I'm really struggling to to get bullish on these charts. They all look like they're cantilevered over the abyss, just waiting for a catalyst to tip them over...
I haven't done a big picture update on the equity markets in a while so I thought today was as good of a time as any. I've been writing for over a year that the major US equity markets have topped and they are now in the very slow process of rolling over. Seven-year bull markets don't die easily. All of the weekly charts shown below are sporting a similar pattern: lower lows and lower highs. I'm also noticing that the time spent at each intermediate peak is dwindling meaning that there is less and less "chop at the top." I interpret this to mean that there are fewer and fewer bulls to support prices with each subsequent rally. If true, there will come a point in time where there is no "subsequent rally" and prices will really start a waterfall decline. Anyway, here are the charts. Let me know what you think.
Small caps are reeeeaaaaalllllyyy lagging lately. While the S&P 500 and DJIA are less than 5% and 3% from their all time highs respectively, small caps are still trading more than 15% below their all time high set back in June 2015. Typically we see small caps on the leading edge of a move, regardless if it's up or down. By definition they're smaller, more thinly traded, and therefore tend to be more volatile than their larger counterparts. So when momentum shifts in the market, they tend to react earlier and in a more dramatic fashion.
So why are small caps stuck in neutral? I can't say exactly why, but I will note that it's a major red flag for the underlying strength of equities in general. If small caps can't get on board, then the rally lacks depth and breadth - both essential ingredients for a healthy bull market.
Maybe they're just late to the party, however, the utter lack of volume during the recent rally suggests big money isn't buying in. Maybe I'm wrong (it's happened before) and this time it will be different. Just letting you know what I'm seeing. That's all for today.
The following weekly charts of the IWM (Russell 2000), S&P 500, and Nasdaq Composite all display the same 10%+ rally off the early February lows, however, they all lack one critical element required for a sustained bull market: volume.
In short, volume has been pathetic. These charts sure don't suggest that investors have been piling into stocks. Take a look at that first chart of IWM where I circled the volume from October 2014 and the volume from February 2016. The difference should be obvious. The rally off the October 2014 lows was accompanied by massive volume. This was a clue that big money investors were indeed buying alongside short covering. The result: a 25% rally to its ultimate top in June 2015. Now contrast that to what we're seeing today. Volume is way below average on all three of the major indices which tells me that the current rally is being driven by short covering only. I see no evidence of institutional buying over the last three weeks.
In my opinion, investors should use this rally to exit any residual long positions. While the equity markets may continue to rally for a bit longer (momentum indicators remain quite oversold and may need longer to normalize), they don't have the solid foundation upon which long-lasting rallies are built.
Finally, one last bonus chart of the NYSE McClellan Oscillator (NYMO), essentially a momentum indicator for the Advance/Decline line. Extreme readings of greater than 50 or less than -50 are very good contrarian indicators. When the NYMO exceeds 50, it tends to be a good time to sell and when it falls below -50, it tends to be a good time to buy. Yesterday's reading clocked in at 105.77, the second highest reading in 20 years. You're welcome to buy here, but you'll be swimming up stream.
From a 30,000 foot perspective, I firmly believe that all US equity markets have topped, and we're on the back side of the bull market. That said, markets don't typically go straight down once the primary trend has changed. There often rollercoaster-esque drops (aka: air pockets) followed by sharp counter trend rallies. But in the end, bear markets are characterized by lower highs and lower lows when viewed on a longer-term horizon.
Now that I have that out of the way, let's take a quick look at the major US equity indices. The graph above is of the S&P 500. I just want to lay out my individual observations and then step back to see what they mean when taken together.
Observation 1: The S&P has put in a strong double bottom as evidenced by the bullish hammers you see around Jan 20 and Feb 11. The February low did not violate the lows from January which, technically speaking, is a bullish indicator.
Observation 2: The current double bottom sure looks a lot like the double bottom from last August/September. We should respect the similarities and be prepared for a similar outcome (ie. a 10-15% rally off the double bottom lows).
Observation 3: Momentum indicators have diverged bullishly throughout the most recent double bottom pattern. See how the MACD (lower panel) held its uptrend while the S&P fell all the way back to its January lows? Same for RSI, although in a less dramatic fashion.
Ok, while the previous observations were bullish, the following are bearish.
Observation 4: The S&P remains in a strong downtrend. The market as a whole topped 9 months ago. If the bull market is still in tact, that's an awfully long stretch for the index not to make new highs.
Observation 5: Volume has been WEAK during the recent rally. This suggests short covering and lack of long-term buying.
Observation 6: The S&P is nearing two points of resistance. First, it's approaching the late January high of 1,947. And second, it's getting close to it's rapidly declining 50 dma. Taken together, these are going to offer fairly significant resistance.
So now you can see why I think the S&P 500 is at a crossroads of sorts. I see both bullish and bearish indicators on the charts, neither of which appears stronger than the other. For what it's worth, I'm seeing the exact same things on the NASDAQ and Russell 2000 - both shown below.
"What should I do?" you may be asking yourself. Well, if you're a long-term investor, then I suggest you sell into the current strength because, as I said earlier, I believe the primary long-term trend has changed to a bear market. Capital preservation is going to be key over the coming months and perhaps years. If you're a trader, then good luck to you. It's really hard to make short term directional calls, especially during a trend-transition. The pops and drops are very extreme and unpredictable.
Good luck and thanks for reading.
Parties are always fun in the heat of the moment, but the hangover can be nasty. That's how I would describe the stock markets at the moment. The party, 2010 through 2014, was basically a straight-up equity buying binge with no meaningful correction along the way. Now that we've topped, the markets are cratering day after day with no relief. This, my friends, is the hangover.
I've selected the IWM Small Cap ETF to demonstrate my point. From the lows of 2009 to the highs of 2015, there was maybe one meaningful correction along the way. That occurred in 2011-2012 during the first Greek "crisis" / debt ceiling debacle. I've highlighted this area with the green box. Besides that, small caps marched higher and higher in a nearly perfect 45 degree ascent. There were literally no other corrections or even sideways chops that lasted more than a couple weeks. When IWM broke above 80 (out of the green box), it proceeded to run 50% higher, without a stop.
This, in my opinion, is exactly why it's now in free fall. When stocks march straight up, they don't have an opportunity to build a base of support. In other words, there's not a large body of investors that have taken a position at a certain level. The result, unfortunately, is that the stock takes the elevator on the way down. With no large body of investors acting as support, sellers are like a hot knife through butter. In effect, we're now reaping what we sowed during the 5-year party.
So what does this mean going forward? Don't be surprised if small caps fall another 15-20% before finding any meaningful support. Sure there might be some sharp counter-trend rallies, but those won't last more than a few days or a week.
Just a couple charts today and a brief comment. First, as you can see above, the rally off the August lows has pretty much been undone over the last two weeks. The steep slide has caused the 50 dma to turn sharply lower, yet again crossing beneath the 200 dma. Just to reiterate, the S&P topped last May which means it's been 8 months now without a new high. The longer this continues the more likely it is we've seen the end of this bull market.
I probably didn't even need to annotate this weekly chart of the Russell 2000 because it's so ugly. That said, I do want to point out a couple things. If you hadn't looked, small caps are down another 1.3% today, placing them firmly beneath the October 2014 Bullard Bottom. Momentum indicators are a disaster with MACD off the charts in the bad direction.
I can't imagine either index falling much more before a decent bounce, but I've clearly been wrong before. My big picture outlook remains unchanged - I think the indexes have topped and we're in the process of rolling over. Major tops take time (possibly years) to unfold. Look again at that weekly chart of the Russell. If we are indeed topping, then the process started in late 2013 - we just didn't know it at the time. Now is not the time to jump into the market if you're a long term investor.
Yep, you read that right. I'm not talking about the August 2015 flash crash lows, I'm talking about the October 2014 Treasuries crash lows. Remember that one? That's when Fed-Head James Bullard was trotted out to say some "soothing words" to stem the bleeding - and it worked. Anyway, based on the nasty pre-market this morning, major indices look like they will open down over 2%. Assuming this carries over to the cash market open at 9:30 am EST, then the small cap Russell 2000 will easily break below its August lows and will be within spitting distance of its October 2014 lows.
A longer term look at the weekly chart shows a beautiful topping pattern starting in late 2013. For the better part of 2014, the index chopped sideways before meekly pushing to new highs in 2015. It quickly deteriorated in the second half of the year and now, as I said above, it's highly likely to re-visit the 1050 area as noted by the blue line.
Shortly before Christmas, I talked about the symmetry taking place on the S&P 500. I have no reason to believe the same won't be true on the other indices, including the Russell 2000. With that in mind, I've highlighted what I believe is a likely scenario for the next year. Once the index reaches the 1050 level, I expect the bulls to start fighting back. Remember, we're in the waning days of a six year, fed-induced bull market - it's not going to roll over and die easily. If/when this scenario does play out, then we might be looking at the shorting opportunity of a lifetime.
Believe it or not, but the huge rally from Friday has already been erased on the Russel 2000. In fact, in the first two hours of trading, the index actually cut below the lows from last week. As you can see on the daily chart above, small caps are clinging to short term support. A couple of closes below that green line is decidedly bearish suggesting a re-test of the October lows. The MACD did not confirm new short term highs from a few days ago and now it just posted a bearish cross. Remember, the Russell 2000 peaked almost six months ago and is off 10% from those levels as of this morning. There is weakness under the surface everywhere right now. Caution is warranted regardless of the screaming bullish headlines that litter the financial media.
Starting with the Dow Jones Industrial Average, we can see the slow motion rollover that's been taking place since late 2014. Selloffs have been met with sharp rallies which have been met by more selloffs and even more rallies. This is classic action during a market top. Big investors - hedge funds, pensions, investment funds, etc. - need to unload massive amounts of shares without overly influencing the market. They obviously want the best prices possible, so they have a vested interest in keeping the market elevated while they distribute. Meanwhile, the dumb money continues to buy their shares thinking that the bull market will continue on its merry way failing to recognize the horrendous internal breadth that's developed over the last six months. So you have very big institutional sellers distributing shares to a group of dumb money investors. This battle manifests itself in textbook style on the chart above.
Why am I so confident the markets have topped? Specific to the DJIA, it just had its first "death cross" in four years (the 50 dma crossing below its 200 dma). In addition, it's made a series of lower lows, now trades below both moving averages, and the MACD and RSI continue to confirm that sellers are in control.
For the most part, the same story applies to the S&P 500 and the Russell 2000. The declines aren't quite as advanced as the DJIA, but they're not too far behind. In reality, these indexes are just catching down to the Dow Transports, which I've posted about many times. Remember, the DJTA is a leading indicator and it's been breaking down badly for many months:
I'm seeing topping action everywhere I look - and this doesn't appear to be a "buy the dip" type correction either. We are waaaaaaaaay overdue for a serious correction. Invest accordingly.