SOME VISUALS MAY BE HELPFUL
Over the past several weeks, our weekly videos have covered the bullet points in the image below. These bullet points were presented when the market was doing well since we knew it was only a matter of time before some type of bearish activity surfaced.
LONG-TERM OUTLOOK
Based on what we know today, the long-term outlook remains favorable. The S&P 500 closed Tuesday above an upward-sloping 200-day moving average and above an upward-sloping 200-week moving average.
As long as the two charts above look as they do today, the longer-term bias will be for the bullish trend to resume and for the S&P 500 to make a series of higher highs. The charts may shift, but they have not shifted yet.
INTERMEDIATE-TERM CONCERNS
Numerous “do not assume anything” data points have surfaced in the last three trading sessions, including heavy volume, concerning gaps, lopsided market breadth, and a handful of “this is starting to veer off the base bullish script” looks. The market has checked some key “bird strike” boxes this week and hence the implementation of the profit-protection plan. Several concerning developments have occurred in the last three trading sessions.
POSSIBLE SUPPORT
While we are looking at a very broad set of data points and charts during each trading session, several key concepts can be summarized in the chart of the S&P 500 below. You can still make a rational argument the move above the green-dotted line in October was a bullish breakout and the current decline is retesting that breakout. Area 1 in the chart below shows a cluster of possible support that lies between Tuesday’s close and the 200-day moving average (red). The 200-day sits at 3044 or 84 points below Tuesday’s close of 3128. Thus, even if Area 1 provides support, it could still be painful in the short-run.
If the S&P 500 cannot make a stand at Area 1, the horizontal green lines are levels that acted as resistance in 2018 and 2019; they may now act as possible support. The point of the chart above is not to imply Area 1 or Area 2 will hold, but rather to communicate there are some reasons to remain patient with stock-related investments. As always, we will learn something either way (bullish or bearish). Area 2 tells us we need to be mentally and tactically prepared for an S&P 500 move all the way back to 2950-ish, which would result in a peak-to-trough correction of 12.88% and additional profit-protection chess moves.
ANOTHER RETEST LOOK
Just like the chart of the S&P 500 above, we can still make a rational argument the stock/bond ratio broke above the downward-sloping green trendline in October and the current correction is retesting the same trendline. If the breakout holds, we learn something. If the breakout fails, we learn something. The close below the lower Bollinger Band speaks to snapback odds.
TYPICAL MARKET RETRACEMENTS
The chart below helps make several points:
It is not unusual for a market to retrace or give back 38.2%, 50.0%, or 61.8% of the prior rally before resuming the prior bullish trend. For now, the market is still in the typical retracement window based on the prior move from the October low to the recent high.
The Bollinger Band center line is rolling over which speaks to a waning trend on shorter-term timeframes. It helps us keep an open mind about worse than expected outcomes.
The S&P 500 closed well below the lower Bollinger Band which says the odds of a short-term move in the other direction have increased a bit.
There is nothing magical about any of this; these are simply examples of guideposts to better understand risk-reward probabilities.
SEMICONDUCTORS - POSSIBLE SUPPORT
In our tech-heavy society, semiconductors can provide insight into the larger economic and market picture. Once again, we can still make a rational argument semiconductors broke out from an ascending triangle formation in October and the current correction is a retest of that breakout. Since retests can pass or fail, as with all charts, we make no assumptions about what the longer-term outcome will be. We should get some useful information either way. If you look closely at the thick horizontal blue line, you can see a cluster of gaps (up and down). That area has acted as both support and resistance in the past and it may be relevant to market participants. If the gap area is to be tested, semiconductors would need to decline further in the coming days.
BIRD STRIKE UNTIL PROVEN OTHERWISE
We will continue to implement our profit-protection strategy until the market proves it needs to be put back on the shelf. We are making no assumptions about market outcomes in the days and weeks ahead.
There is enough “that is concerning” evidence in hand to keep an open mind about much worse than expected outcomes. The charts above help us keep an open mind about better than expected outcomes as well.
The current intermediate-term bias is for lower prices until proven otherwise. From a maximum flexibility perspective, it is good to keep in mind sharp dislocations that occur in the context of strong trends can be followed by sharp reversals. We can find numerous historical examples of a sharp reversal including the 1950 case shown below. It is very important we remain nimble and prepared for all outcomes.
This post is written for clients of Ciovacco Capital Management and describes our approach in generic terms. It is provided to assist clients with basic concepts, rather than specific strategies or levels. The same terms of use disclaimers used in our weekly videos apply to all Short Takes posts and tweets on the CCM Twitter Feed, including the text and images above.