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posted on 21 May 2017

A Flash Of Excitement

Written by , Clarity Financial

Review and Update

After almost two months of an "eerie" calm, the markets hit some turbulence last week. While "fake news" from the media has become quite a common occurrence as of late, the latest batch came courtesy of the New York Times.

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As I penned on Friday:

"As suspected, it did end with a bang on Wednesday as markets dropped sharply on the news of a "leaked" memo to the New York Times which suggested an attempted 'obstruction of justice' charge by the President. James Comey, former head of the FBI, will now be questioned by Congress next week and asked to provide that memo. In the meantime, the Justice Department has now appointed a special prosecutor to investigate the "Russia Connection."

As I discussed on "The Lance Roberts" show on Thursday and Friday, such a memo is unlikely to actually exist, and even if it does, is likely to be innocuous at best. Comey would potentially have a high degree of liability considering he already has stated, under oath, that he was not aware of any such attempt to impede an investigation. Perjury is a serious issue.

The problem for The Washington Post, The New York Times, CNN, and other major media outlets, the rush to try and "pin the tail on Trump," has led to a consist dump of #FakeNews which continues to impugn the journalistic integrity of those institutions.

However, while the Washington intrigue is certainly interesting, the question is "why after all these months did it matter to the markets now?"

The answer is simple. It potentially stalls all the legislative actions the markets have been banking on for the "Trumpflation" trade from tax cuts to infrastructure spending. A look at the bond market gives you a clearer picture of the "fading" hopes on an inflation-driven economic boom.

Importantly, as shown below, the market quickly recovered from Wednesday's sell-off and remained above the 50-day moving average for the week.

That's the good news

The not so good news, in the short-term, is the daily "SELL" signal was triggered (lower panel) which often denotes periods of increased volatility and corrective actions until they are complete. Despite the rally on Thursday and Friday, I suspect the "shot across the bow" on Wednesday was just that and suggests reflexive rallies should be used to rebalance and de-risk portfolios for now.

However, as shown below, on a longer-term basis the backdrop is more indicative of a potential correction rather than a further advance. With the initial intermediate-term (weekly) "sell" signal triggered at historically high levels, the downside risk currently outweighs the potential for reward...for now. Furthermore, the secondary (lower) weekly "sell" signal is also very close to triggering from an extremely high level as well.

For a bit of context, the chart below shows the 20-year history of the market with the combined weekly "sell" signals. The vertical red shaded bars highlight the periods when both weekly "sell" signals were triggered from very high levels as we are currently at risk of doing.

Furthermore, the underlying internal have continued to weaken over the last week which has remained a concern over the last couple of months.

The 10-year chart below, while a bit cluttered, shows several very important things worth considering currently. First, the top part of the weekly chart is essentially a buy/sell indicator. Each sell signal previously, has been indicative of a correction. The middle of the chart is a combination of internal strength indicators from the number of stocks on bullish buy signals, advancing vs declining issues and volume, and the percent of stocks above their 200-day moving average.

With all the internal indicators currently on the decline, when combined with a stochastic "sell signal," there is a higher probability of a correction in the weeks ahead. While this time could certainly be different, it is probably worth noting that making such a bet with your retirement money has not often ended well.

Rich Breslow summed the current environment up well on Friday:

"Markets can trend, range trade, and correct. But one thing they can't do under the current scenario is time-correct. The minute they stop moving, a powerful, even if short-lived, impulse takes over to reevaluate, cherry-pick and average down. Even if you're sure the story hasn't run its course, it takes real moxie to remain exposed to the other side of trades you were very comfortably holding for the previous weeks and months.

We're all leery of getting caught in over-crowded trades. Nothing feels more teeming than new trades predicated on emotion. Even if you feel very strongly about the subject. This is a be nimble, very nimble, environment when we've been rewarded time and again for buying and holding. Traders will need skills that have atrophied over years. Another reason we are years away from 'normal.'"

I suspect he is right.

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