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A Technical Look At the Stock Market


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I thought it would be instructive to look at the technical picture for the S&P 500 since we are at a crucial point in determining whether there will be a new bull market leg in our future or something less positive.

The graph above is one I shared last month with our investment committee but updated for recent market action.  I have been keeping track of this technical pattern since the summer and have been updating this graph accordingly.  The chart depicts two different patterns, a megaphone pattern and a rising wedge pattern.  You can see that the megaphone pattern had been in existence since the beginning of the January, 2018 correction and the rising wedge pattern began with the end of the December 2019 correction.

What I was watching for was a break above the top of the megaphone when we got to the July 2019 all-time high on the S&P 500 Index.  What we got instead was a break below the bottom of the rising wedge and several weeks of the market moving higher but not with a move strong enough to return to the wedge.

During the August pullback, I drew in two potential paths for the market: (1) the Path to 3300 (orange lines), and (2) the path to 2100 (pink lines) since both were possibilities at the time given the uncertainty of the economy.  Note that I have added some commentary on the graph that might be useful in helping to understand my reading of the market action.

Since August, the Fed has cut rates and started to expand its balance sheet.  Those two sources of easy money and liquidity have driven stock prices higher, to new all-time highs on the S&P 500 Index.  Despite not being able to move back above the bottom of the rising wedge, the Fed’s intervention has powered the market higher to follow the orange path to 3,300.  There is an entirely separate discussion to be had on the reason for the increase in liquidity (problems in the Repo market being one) that could ultimately move the market to the 2100 level on the index, but that is dependent upon many factors that are not quite in play yet (e.g., possible negative resolution of the trade wars, impact of negative interest rates in Europe, a recession, election of a president that could scare investors, unforeseen geopolitical issues, etc.).   Remember what I’ve written on the blog many times – invest what you see, not what you believe.  Today we see that the Fed’s liquidity program is good for the stock market in the intermediate term so it is critical to have a plan to profit from it.

On 11/20/2019, I wrote this to our investment committee:  “we have now reached a critical technical level for the index.  Yesterday, we closed above the black horizontal line I drew at 3,118.82 (a 3120.46 close) however today we are trading below it.  This horizontal line represents a level of 3% above the July closing high and for a new bull market leg higher to 3,300, we need to either close above it for three consecutive market days or to pullback to the July high of 3,027.98 and then break above the 3,118.82 level in a move toward 3,300.”   You can see on graph above that since then the index has fallen back to the top of the megaphone pattern (the rising green line) and we are most likely headed toward the July all-time high – we may not make it all the way back there since the expansion of the Fed’s balance sheet is a powerful tool, pushing money into the stock market, but this should give us a chance to put some funds to work a prices a bit cheaper than we have seen the past several weeks.

It looks like the odds are on the market continuing to move higher after a brief pullback, with a subsequent move to 3,300-ish on the index.  How did I get 3300 as a target?  I am old school – we learned to do measured targets in the days before all of the technology brought technical analysis to the masses.   We get our measured target from the graph above by finding the point difference from December 2018 low on the index, 2400-ish on the index, and the low from the breakdown of the rising wedge lower boundary, 3000-ish on the index, and adding half the difference to 3000-ish.  In other words, it is:

Measured Target =((3,000 – 2,400) x 0.5) + 3000 = 3300

Yes, it is old school but it has served me well over the years in managing clients’ portfolios, so no reason to give up on the process.

The break above the July high led to increasing equity exposure to banks, tech, biotech, and cyclicals which should all benefit from a liquidity driven market risk increase while reducing cash and fixed income investments.

Additionally, with the Federal Reserve now saying that their 2% inflation target is being set aside and that they will allow inflation to move above 2% should also be good for gold, commodities (Energy extraction, refining and transporting;  Agricultural growing and processing;  and Metals – mining and production), in addition to banks.

Our current strategy has been to reduce consumer staples and defensive stocks as the market has been juiced higher by Fed liquidity.  We have slowly been adding to the industries that should benefit from Fed liquidity.  We will take advantage of the sell-off to the July highs by adding to current positions or starting new ones in targeted companies that we want to own but did not previously want to pay the valuations seen at the top of the market.

I’ll be back on the blog with updates as the current change in the market picture plays out.