In yesterday’s market outlook I said that the U.S. stock market would probably retest its lows in the short term, while the medium term is bullish.
The S&P 500 is doing that right now.
Here are some signs that the stock market will fall a little more in the short term (i.e. the next week) before rallying into 2019.
*Let’s analyze the stock market’s price action by quantifying technical analysis. For the sake of reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.
First breakdown below the 200 day moving average
For the first time since March 2016, the S&P has closed below its 200 day moving average for 2 consecutive days.
Such long streaks above the 200 day moving average are uncommon. When they’re broken:
- Some more short term weakness usually follows.
- This is not the start of a bear market. 40%+ bear markets are preceded by much more volatility, which means that closes below the 200 dma are common before a bull market tops.
This is what happens next to the S&P 500 when it closes below its 200 dma for 2 consecutive days, for the first time in 2 years.
As you can see, this is uncommon.
Let’s relax the parameters. This is what happens next to the S&P 500 when it closes below its 200 dma for 2 consecutive days, for the first time in 1 year.
As you can see, the stock market tends to fall a little more in the next 1 week, but the long term is decent.
1 year later, the S&P was up 77% of the time. The 3 “bearish cases” saw tiny losses (all within -3%). None of these cases occurred just before the 2007, 2000, 1973, and 1968 bull market tops.
A lot of red days
Looking at the S&P 500, what immediately stands out is the number of “red days” there have been in the past month.
“Red days” = when the S&P closes lower than its daily open.
Over the past 22 trading days, only 4 days have seen the S&P close higher than its open.
Such intense selling is uncommon, especially soon after an all-time high.
Here’s what happened next to the S&P 500 (historically) when the S&P closes higher than its open in less then 5 out of the past 22 days, after making a 3 year high.
As you can see, the stock market tends to fall in the short term (next 1 week).
Is this the end of the bull market?
Here’s one of the most popular charts that traders are looking at right now. It demonstrates how the S&P 500 is making a big “bearish divergence” with monthly RSI.
Seems like the end of the world right?
These “bearish divergences” can last for a long, long time.
- Big bearish divergence from 1996 – 2000 (bull market top in 2000)
- Big bearish divergence from the late-1950s to the end of the 1960s (bull market top in 1968).
As you can see, this is NOT a useful market timing tool. An indicator that says SELL for 4 years before a market crashes is not useful.
Signs of a bull market top in 2019
In last week’s market summary I outlined the stock market’s main problem right now: the housing market is starting to deteriorate.
Housing is one of the earliest leading indicators for the stock market and the economy. It tends to deteriorate 1-2 years before a bull market tops.
The Dow Jones Home Construction Index measures homebuilder stocks, which have tanked this year.
- The Home Construction Index is now -25% below its 200 day moving average.
- Meanwhile, the S&P has not fallen significantly. It is within 1% of its 200 day moving average.
Here’s the Home Construction Index
Here are historical cases from 2000-present in which the Home Construction Index was -25% below its 200 day moving average, but the S&P was within 1% of its 200 dma (i.e. divergence)
- June 5, 2006
- July 24, 2007
- October 22, 2018 (current case).
As you can see, this tends to happen less than 1.5 years before a bull market tops. But at the same time, this doesn’t happen when a bear market first begins.
Remember: housing is a leading indicator.
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*Our discretionary outlook is usually, but not always, a reflection of how we’re trading the markets right now. We trade based on our clear, quantitative trading models, such as the Medium-Long Term Model.
*Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.