posted on 02 May 2016
by Lance Roberts, Clarity Financial
Over the last couple of week's, I have written extensively about the breakout of the market above the downtrend resistance line that traced back to the 2015 highs.
I also stated that it was probably a trap and that I will be stopped out in fairly short order. But that is the risk of managing money.
It was only a matter of time before the extreme short-term extension of the market begins to correct. Like stretching a rubber band to its limits, it must be relaxed before it is stretched again. The question is whether this is simply a "relaxation of the extension" OR is this a resumption of the ongoing topping and correction process?
Let's take a look at a few charts to try and derive some clues as to what actions we should be taking next.
First of all, it is worth noting that despite all of the recent excitement of the markets advance, it remains extremely confined in a sideways trading range. This can either be good or bad news.
How do we know the difference? Normally, fundamentals tell the story. When earnings are still rising, market consolidations tend to resume to the upside. However, declining earnings have historically marked market topping processes much as we see today.
Back to our first chart above, I have denoted the previous declining market trend and an adjusted downward trend line to account for the most recent peak. Both of these downward trending price lines will now act as resistance to the next attempt by the market to rally higher.
With the markets still extremely overbought from the previous advance, the easiest path for prices currently is lower. The clearest support for the markets short-term is where the 50 and 200-day moving averages are crossing. I currently have my stop losses set just below this level as a violation of this support leaves the markets vulnerable to a retest of February lows.
On a short-term (daily) basis, the current correction is still within the confines of a simple "profit-taking" process and does not immediately suggests a reversal of previous actions. As shown in the chart below, support current resides at 2040 with the 50-day moving average now trading above the 200-day.
It is worth noting the similarity (yellow highlights) between the current rally and peak versus the rally and peak during the October through December advance.
Better Smelling Breadth
The good news is that the advance-decline line, currently remains a positive backdrop to the recent price action. My friend and colleague, Dana Lyons, picked up on this last week:
Risk Still High
Given the fundamental and earnings backdrop, the longer-term market dynamics are still heavily weighted against the bulls. As shown in the next chart, despite the recent surge higher in prices, the technical backdrop still remains bearishly biased.
With the exception of the number of stocks trading above their 200-dma, which still remains well below levels when prices were last at these levels, every other indicator is at levels and behaving as if we are in a more protracted bear market decline.
The question remains whether the markets will continue to "buy" the Federal Reserve's "forward guidance" long enough for fundamentals to play catch up with the fantasy, or not. Historically speaking playing "leapfrog with a Unicorn" has tended to have painful outcomes.
A Note On Oil, The Dollar & Rates
Last week, I wrote a fairly extensive post on why I think oil prices are nearing their peak and made a case for trimming back on oil & energy related exposure. To wit:
A technical look at oil prices also suggests near-term profit taking in energy-related positions is likely a good idea. As shown, oil prices are not only trading at the top of a long-term downtrend channel but are also pushing 2-standard deviations above the mean.
With momentum and prices at extreme overbought conditions, a near-term reversion is very likely. I have noted each previous peak price in oil with vertical blue-dashed lines.
Of course, one of the main drivers of such a reversion would be a reversal of the recent weakness in the dollar. Like the advance in oil, the decline in the dollar has also been just as extreme. As shown below, denoted by yellow highlights, each previous downside extension of the current magnitude has resulted in a fairly sharp reversal.
With the Federal Reserve caught in their own "trap" of "strong employment and rising inflation" rhetoric, the markets may stay to worry about a rate hike in June. A perception of higher interest rates would likely reverse flows back into the dollar, and by default U.S. Treasuries, pushing the dollar higher and rates lower.
Speaking of rates, I suggested a couple of weeks ago as rates pushed 1.9% that it was time to once again add fixed income to portfolios. That call has been prescient and was even supported just recently by Jeffrey Gundlach at Doubleline. However, a recent article by Kessler Companies picked up on a key reason why I continue to suggest rates will fall to 1% in the future.
I couldn't agree more which is why I continue to buy bonds every time rates approach 2%.
Okay, enough for now.
Next week should give us more information about what to do next.
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