Tag: S&P 500

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V- or M-shaped correction?

Last week I mentioned that there are few “V-shaped” corrections and plenty with a “W-shape”. There are also a few with an “M-shape”, leading to a major market sell-off. Here are some examples on Dow Jones Industrial Average.

2001 is the only good example I can find of a V-shaped correction.

Dow Jones Industrial Average

It rolled over later in 2002 into a more conventional W-shape bottom with several tests of support at 7500.

Dow Jones Industrial Average

This was followed by the banking crisis of 2008 which started with an M-shape in 2007. Successive false breaks above resistance (orange arrows) were followed by breach of support (red arrows)…before Lehman Bros filing for bankruptcy on September 15 led to a major capitulation.

Dow Jones Industrial Average

2011 is nowadays considered a secondary movement but at the time caused widespread alarm. Starting with an M-shaped top, it broke support in August before forming a W-shaped bottom with several tests of support at 11000.

Dow Jones Industrial Average

2015 was a more conventional W-shape precipitated by falling oil prices.

Dow Jones Industrial Average

Now, in 2018, we have the makings of either a W-shaped correction or an M-shaped reversal. The false break above resistance at 26500 is definitely bearish but was followed by a bullish higher low at 24000.

Dow Jones Industrial Average

There are three possible options:

  1. Completion of a W-shape correction, with breakout above 27000;
  2. An M-shaped reversal, with a fall below 23500; or
  3. A lengthy consolidation reflecting uncertainty, as in 1999 to 2001.

Dow Jones Industrial Average

At this stage, option 1 is most likely. Buybacks and strong Q3 earnings are likely to counter bearish sentiment.

That would change if we see:

A negative yield curve, where the 3-month T-bill rate crosses above 10-year Treasury yields;

Yield Differential

Rising troughs above 1% on the S&P 500 21-day Volatility Index; or

S&P 500

Bellwether transport stock Fedex follows-through below support at 210.

Fedex

Remember that there is nothing stable in human affairs; therefore avoid undue elation in prosperity, or undue depression in adversity.

~ Socrates

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Two years is a long time

An outcome where neither Republicans nor Democrats control both chambers provides markets with reassurance that nothing too radical will emerge, making the outlook for the next two years appear more predictable and the settings more stable……But the complacency might be premature. ~ Stephen Bartholomeusz

With Democrats in control, Donald Trump is unlikely to get further tax cuts through Congress. Even a large infrastructure spending program, which both major parties support, is unlikely to enjoy a smooth passage through the House because of a polarizing President and a federal budget deficit already close to 5.0% of GDP.

The Fed will continue to raise interest rates in order to contain inflationary pressures, fueled by low unemployment and the current budget deficit. Rising average hourly wage rates warn that the Fed will be forced to act.

Average Hourly Wage Rate

Earnings growth rates are likely to slow because of higher interest rates, higher wages and higher input costs from imports and trade tariffs (although a strong Dollar may soften the blow). But there is no sign of this in Q2 2018, with profits rising and employee compensation falling as a percentage of value added.

Corporate Profits and Employee Compensation as a Percentage of Value Added

Restraint from buybacks in October — the four weeks prior to earnings releases are known as the “blackout period” — may have contributed to the severity of the recent correction. But now most earnings have been reported and buybacks are likely to return with a vengeance, taking advantage of low prices. I expect support at October lows to hold, though there is likely to be another test in the next few weeks.

Declining Twiggs Money Flow peaks on the S&P 500 warn of selling pressure and it is likely to take several months for confidence to be restored. Recovery above 2850 would be bullish, suggesting another advance.

S&P 500

The Nasdaq 100 respected its long-term rising trendline at 6600. Again, recoveries take time: there are few “V-shaped” corrections and plenty with a “W-shape”.

Nasdaq 100

Buybacks and strong reported Q3 earnings are likely to counter bearish sentiment but there is one wild-card. Trade is one of the few areas where the President still has the reins and he is likely to make full use of them. I suspect that the Chinese will attempt to wait him out, making conciliatory noises but doing little that is concrete, which is likely to frustrate Trump further. He may try to force a deal through before the next election in two years. That could only end badly.

The two most powerful warriors are patience and time.

~ Leo Tolstoy

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Nasdaq and S&P 500 rally

The Nasdaq 100 rallied now that mid-term election results are emerging largely as expected. Faith in the primary up-trend is growing but it will take several weeks, if not months, for confidence to be restored and memory of the correction to fade. Hesitancy and a second test of new support at 6600/6700 are likely. There are few “V-shaped” corrections of this magnitude. Most are “W-shaped”, as in the first quarter.

Nasdaq 100

The S&P 500 displays a similar rally but it will take time for Twiggs Money Flow to break the descending trendline and signal that buying strength is restored. Expect another test of support at 2600/2650.

S&P 500

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Buckley’s chance that rate hikes will slow

Average hourly wage rates are rising, with Production & Non-Supervisory Employees growing at an annual rate of 3.20% and All Employees at 3.14%.

Average Hourly Wage Rate

This is a clear warning to the Fed that underlying inflationary pressures are rising. There is Buckley’s chance* that they will ease off on rate hikes.

The Fed adopts a restrictive stance whenever hourly wage rate growth exceeds 3%, illustrated below by a high or rising Fed Funds Rate.

Average Hourly Wage Rate

The market is adopting a wait-and-see attitude ahead of Tuesday’s mid-term elections. Stocks like Apple (AAPL) have been sold down on strong volume despite good earnings results: earnings per share of $2.91 and revenue of $62.9 billion for Q4-18, compared to consensus estimates of $2.79 and $61.5 billion.

Apple

Optimism over a possible trade deal with China may not last the week.

A harami-like candle on the S&P 500 reflects indecision, while bearish divergence on Twiggs Money Flow warns of long-term selling pressure. Breach of 2550 is still unlikely but would warn of a primary down-trend.

S&P 500

The Nasdaq 100 tells a similar story, with primary support at 6300.

Nasdaq 100

* William Buckley was an English convict transported to Australia. He escaped when the ships laid anchor in Port Phillip Bay in 1803. The nearest permanent settlement, Sydney, was more than 1000 km away and, considered to have no chance of survival, he was given up for dead. Thirty-two years later, having lived among the Wathaurung Aboriginal people, he emerged from the bush when a settlement was established at Port Phillip in 1835. “Buckley’s chance” is an Australian colloquialism meaning having no chance at all.

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Nasdaq warns of broad market correction

Tech stocks fell sharply, with the Nasdaq 100 closing below support at 7400, warning of a correction. Twiggs Money Flow (21-day) cross below zero indicates medium-term selling pressure. Follow-through of the index below 7300 would signal a correction to test 7000.

Nasdaq 100

The S&P 500 has so far respected support at 2870. Breach would confirm  a broad market correction and test the rising LT trendline at 2800.

S&P 500

Asia

In China, the Shanghai Composite Index is headed for another test of primary support at 2650. Trend Index peaks at/below zero indicate long-term selling pressure. Breach of 2650 would offer a long-term target of 2000, the 2014 low.

Shanghai Composite Index

India’s Nifty is undergoing a strong correction. Breach of support at 10,000 would warn of a primary down-trend.

Nifty Index

Europe

Dow Jones Euro Stoxx 50 is again testing primary support at 3300. A Trend Index peak at zero warns of mounting selling pressure. Breach of 3300 would warn of a primary decline, with a target of 3000.

DJ Euro Stoxx 600 Index

The Footsie is also testing primary support, at 7250, but a recovering Trend Index indicates buying pressure.

FTSE 100 Index

Rising US interest rates are already hurting developing economies like India and China, and a looming US-China trade war would threaten a global contraction.

Only when the tide goes out do you discover who’s been swimming naked.

~ Warren Buffett

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S&P 500 cracks trendline

The S&P 500 penetrated its secondary trendline, indicating a correction to test support at the LT trendline at 2800. Shorter-term 21-day Twiggs Money Flow crossed below zero to warn of a secondary correction. Follow-through below the January high at 2870 would confirm.

S&P 500

Nasdaq 100 breach of 7400 would also confirm, signaling a correction to test support at 7000.

Nasdaq 100

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East to West: Trade tariffs spark rally

Commodities rallied and Asian stocks found support after a three-month sell-off.

DJ-UBS Commodity Index

From Reuters (September 19):

Copper jumped to its highest in three weeks on Wednesday, boosted by a weaker dollar after a new round of U.S.-China trade tariffs were not as high as previously expected.

China will levy tariffs on about $60 billion worth of U.S. goods in retaliation for U.S. tariffs on $200 billion worth of Chinese goods. Washington’s new duties, however, were set at 10 percent for now, rising to 25 percent by the end of the year, rather than starting immediately at 25 percent…….

“In some ways the bad news had been priced into the markets and, if anything, the news on trade had been slightly less severe than we had thought it would be,” said Capital Economic analyst Caroline Bain.

“It’s still too early to talk about this as sustainable … it just seems to be a bit of a relief rally after all of the bad news.”

The Shanghai Composite Index rallied off primary support at 2650, a slight bullish divergence on the Trend Index signaling short-term buying pressure. Penetration of the descending trendline would suggest that a bottom is forming.

Shanghai Composite Index

Japan’s Nikkei 225 is testing its January high at 24,000.

Nikkei 225 Index

India’s Nifty is testing support at 11,000. Long tails indicate buying pressure. Respect of support would signal another advance.

Nifty Index

Europe

Dow Jones Euro Stoxx 50 rallied off primary support at 3300 but is yet to break the down-trend.

DJ Euro Stoxx 600 Index

The Footsie also rallied, finding support at 7250, but a declining Trend Index warns of continued selling pressure.

FTSE 100 Index

North America

The S&P 500 rallied off the new support level at 2875 and is likely to test its long-term target of 3000.

S&P 500

The Nasdaq 100, however, continues to test support at 7700. Breach would warn of a correction to test 7000.

Nasdaq 100

Canada’s TSX 60 found support at 950 but declining peaks on the Trend Index continue to warn of selling pressure.

TSX 60 Index

Markets are dominated by one concern, a US-China trade war, and volatility is likely to remain high until a resolution is found.

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How will a bond bear market affect stocks?

10-Year Treasury yields broke out of their triangular consolidation at 3.00%, while the Trend Index recovered above zero signaling a fresh advance.

10-year Treasury Yield

Importance of resistance at 3.00% is best illustrated on a long-term monthly chart. Yields declined for more than three decades (since 1981) in a bond bull market but the rise above 3.00% completes a double-bottom reversal, warning of rising yields and a bond bear market. Target for the advance is 4.50%.

10-year Treasury Yield

The yield differential between 10-year and 3-month Treasuries has declined since 2010, prompting discussion as to whether a flat yield curve will cause a recession.  Interesting that the yield differential recovered almost 20 basis points in September, with long-term yields rising faster than short-term. Penetration of the descending trendline would suggest that an imminent negative yield curve is unlikely.

10-year Treasury Yield

How would a bond bear market affect stocks?

Capital losses from rising yields on long-maturity bonds would increase demand for shorter maturities, driving down short-term yields and causing a steeper yield curve. A bullish sign for stocks.

Inflation is low and the rise in long-term yields is likely to be gradual. Another bullish sign.

The last bond bear market lasted from the early 1950s to a peak in September 1981. Higher interest rates were driven by rising inflation ( indicated below by percentage change in the GDP implicit price deflator). The 1975 spike in inflation was caused by the OPEC oil embargo in retaliation for US support of Israel during the 1973 Yom Kippur war.

1950 to 1981: 10-Year Treasury Yields and GDP Implicit Price Deflator

Stock prices continued to climb during the bond bear market, apart from a 1973 – 1974 setback, but the Price-Earnings ratio fell sharply in ’73-’74 and only recovered 10 years later, in the mid-1980s.

1950 to 1981: S&P 500 and PE Ratio

Alarmists may jump to the conclusion that a bond bear market would lead to a similar massive fall in earnings multiples but there were other factors in play in 1975 to 1985.

First, crude prices spiked after the OPEC oil embargo and only retreated in the mid-1980s.

1960 to 1985: West Texas Intermediate Crude prices

The rise of Japan also threatened US dominance in global markets.

1960 to 1985: Nikkei 225 Index

We should rather examine the period prior to 1973 as indicative of a typical bond bear market. The S&P 500 Price-Earnings ratio was largely unaffected by rising yields. Real interest rates actually decreased during the period, with the gap between 10-year yields and the inflation rate only widening near the 1981 peak.

At present, real interest rates are near record lows.

1981 to 2018: 10-Year Treasury Yields and GDP Implicit Price Deflator

We can expect real interest rates to rise over time but that is unlikely to have a significant impact on earnings multiples — unless there is a strong surge in long-term yields ahead of inflation.

 

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East to West: Bonds & tariffs hurt developing markets and crude prices

10-Year Treasury yields are consolidating in a triangle below long-term resistance at 3.00 percent. Breakout above 3.00 would signal a primary advance, ending the decades-long bull market in bonds. This would have a heavy impact on developing economies, including China, with a stronger Dollar forcing higher interest rates.

10-year Treasury Yields

A Trend Index trough above zero would signal buying pressure and a likely upward breakout.

Crude oil prices, as a consequence of higher interest rates and the threat of trade tariffs, are starting to form a top. Bearish divergence on the Trend Index warns of selling pressure. Breach of support at $65/barrel would signal reversal to a primary down-trend.

Nymex Light Crude

Commodity prices are leading, breach of support at 85.50 already having signaled a primary down-trend.

DJ-UBS Commodity Index

China’s Shanghai Composite Index is in a primary down-trend. Trend Index peaks below zero warn of selling pressure. Breach of support at 2700 is likely. The long-term target is the 2014 low at 2000.

Shanghai Composite Index

Germany’s DAX is headed for a test of primary support at 11,800. Descending peaks on the Trend Index warn of secondary selling pressure. Breach of primary support is uncertain but would offer a target of 10,500.

DAX

The Footsie also shows secondary selling pressure on the Trend Index, warning of a test of primary support at 6900/7000.

FTSE 100

In stark contrast, North American tech stocks have made huge gains in the last four months, but are now retracing to test support. Breach of the rising trendline and support at 7400 would warn of a correction; a test of the long-term rising trendline at 7000 the likely target.

Nasdaq 100

The S&P 500 has also made new highs. Penetration of the rising trendline would warn of a correction to the LT trendline at 2800.

S&P 500

North America leads the global recovery, developing markets including China are falling, while Europe is sandwiched in the middle, with potential loss of trade from East and West if a trade war erupts.

From the AFR today:

President Donald Trump said he’s ready to impose tariffs on an additional $US267 billion in Chinese goods on short notice, on top of a proposed $US200 billion that his administration is putting the final touches on.

“….I will say this: the world trading system is broken.” Trump is “dead serious” in his determination to push China to reform its trade policies, [White House economic adviser Larry Kudlow] added.

Can’t say he didn’t warn us.

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East to West in three charts

The S&P 500 is making new highs while a rising Trend Index indicates buying pressure. Target for the advance is 3000.

S&P 500

China’s Shanghai Composite Index is in a primary down-trend. Trend Index peaks below zero warn of selling pressure. Breach of support at 2700 is likely and would offer a long-term target of the 2014 low at 2000.

Shanghai Composite Index

The Footsie broke support at 7600. Follow-through below 7500 warns of a correction to test primary support at 6900/7000.

FTSE 100

North America leads the global recovery, China is falling, while Europe is sandwiched in the middle, with potential loss of trade from East and West if a trade war erupts.

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