Written by Lance Roberts, Clarity Financial
This past week, the market advanced 3% heading towards my target of 2400. The Dow broke above 19700 and is within striking distance of the “psychological” summit of 20,000.
With just 250 points to go, it is extremely likely traders will try and push stocks to that level by Christmas. Woo Hoo!
Caveat Emptor!
Before you go printing up your “Dow 20,000” hats, there is a dark side to the advance.
If you go outside and throw a ball into the air, it will travel until the momentum of the ball is overtaken by gravity. There is, just for a very brief moment, a point where the ball is stationary. However, eventually, gravity wins.
The same is true for market prices. As I discussed on Friday:
“The importance of understanding the nature of reversions is critical for investors. Markets rarely move in one direction for very long, notwithstanding overall trends, without a correction process along the way. While the chart below shows this clearly for the overall market, it applies to individual sectors of the market as well.”
“Importantly, notice the bottom two part of the chart above. When there is a simultaneous culmination of overbought conditions combined with a more extreme deviation, corrections usually occur back to the underlying trend.
This can also be seen in the next chart as well. While the ‘Trump Rally’ has pushed asset prices higher and triggered a corresponding ‘buy signal,’ that signal has been triggered at very high levels combined with a very overbought condition. Historically, rallies following such a combination have not been extremely fruitful.”
While the “exuberance” of the Trump rally has certainly awakened the “animal spirits,” the sustainability of the advance from such egregiously overbought conditions is questionable. David Rosenberg weighed in on this point via The Globe & Mail:
“Okay, so the president-elect is now at 3 percent, again skewed by two or three sectors. Big deal. Ronald Reagan, who was the original ‘Make America Great Again’ advocate (as opposed to a copycat), saw the equity market soar 6 percent in his first month in office.
Guess what? The market peaked less than four weeks into his term and for the next two years we had an economic downturn and a 25-percent slide in the stock market. The combination of rising bond yields, Fed tightening and a stronger dollar took care of that honeymoon.
After all, we all know what happens when the honeymoon is over. The hard work begins.
That slump we just saw in October export volumes and widening in the trade deficit is surely just an early sign of what is to come.
Before The Donald does anything on his first hundred days, something tells me the lagged impact of the tightening in financial conditions associated with the recent bounce in interest rates and appreciation of the U.S. dollar is going to come back and bite the economy in the tush, as was the case heading into 2016.”
