Written by Lance Roberts, Clarity Financial
Early Wednesday morning I penned a “Quick Take“ discussing the breakout of the two-month long consolidation process.
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To wit:
“The bulls are ‘attempting a jailbreak’ of the ‘compression’ that has pressured markets over the last two months.
This breakout will provide a reasonable short-term trading opportunity for portfolios as I still think the most probable paths for the market currently are the #3a or #3b pathways shown above.
If we get a confirmed break out of this ‘compression range’ we have been in, we will likely add some equity risk exposure to portfolios from a ‘trading’ perspective. That means each position will carry both a very tight ‘stop price’ where it will be sold if we are wrong as well as a “profit taking” objective if we are right.”
On Thursday, that “jailbreak” occurred with a move above resistance and the previous closing high downtrend.
From a bullish perspective there are several points to consider:
- The short-term “sell signal” was quickly reversed with the breakout of the consolidation range.
- The break above the cluster of resistance (75 and 100-dma and closing high downtrend line) clears the way for an advance back to initial resistance at 2780.
- On an intermediate-term basis the “price compression” gives the market enough energy for a further advance.
With the market close on Friday, we do indeed have a confirmed breakout of the recent consolidation process. Therefore, as stated previously, we reallocated some of our cash back into the equity side of our portfolios.
From a bearish perspective the are also several points to consider:
- The volume and breadth of the market rally has been “okay” but not stellar, which suggests this was more of a forced “short-covering” rally than a turn in overall conviction.
- The rally, as Doug Kass notes below, was led by a surge in energy prices due to the Iran escalation over the nuclear agreement.
- With everyone seemingly short the U.S. dollar, short Treasury bonds and long oil prices, a reversal of that excess positioning seems likely from a contrarian point of view. Such would definitely pressure stock prices lower.
- Complacency has once again returned to the market very quickly following such a long consolidation process as noted in the chart below, not only is there a breakout in stocks but also volatility.
As I noted in last Tuesday’s update:
“Despite the recent corrective process, investors still remain primarily allocated to equities as shown by the Rydex allocation measures below. With the market testing its longer-term bullish trendline from the 2016 lows, Rydex Bear and Cash allocations remain at low levels while bullish allocations have not fallen much from their recent highs.”
What is clear is there was actually very little “capitulation” by investors over the last couple of months which potentially limits any advance in the markets from current levels.
But, while “everyone loves a good bullish thesis,” let me restate the reduction in the markets previous pillars of support:
- The Fed is raising interest rates and reducing their balance sheet.
- The yield curve continues to flatten and risks inverting.
- Credit growth continues to slow suggesting weaker consumption and leads recessions
- The ECB has started tapering its QE program.
- Global growth is showing signs of stalling.
- Domestic growth has weakened.
- While EPS growth has been strong, year-over-year comparisons will become challenging.
- Rising energy prices are a tax on consumption
- Rising interest rates are beginning to challenge the valuation story.
“While there have been several significant corrective actions since the 2009 low, this is the first correction process where liquidity is being reduced by the Central Banks.”
