Tuesday, March 20, 2018

Post Correction

It has been about a month since the market bottomed and corrected roughly 12% from peak to trough in all of 10 trading days.  Since the trough low and reversal day on February 9th the S&P has rallied 10% off the lows in a choppy fashion.  The leader from the lows has clearly been in technology stocks as both the Nasdaq and NDX have rocketed back to new highs on their rally attempts.  The current weakness has taken both of these indices below their prior highs creating a potential double top.  The good news is the big four indices have made higher lows over the last month setting up a wedge formation.  What is more concerning is the negative divergence in momentum and breadth that has been created as price was making new highs in the Nasdaq and NDX.  Both the RSI and % of stocks trading above their 50 day moving average failed to confirm new highs.  Typically markets roll over when not accompanied by strong breadth and momentum readings.



Another area we'll be watching on a longer term chart is the 20 week moving average accompanied by the bollinger bands.  Urban Carmel over at the Fat Pitch blog had a nice review of how this has played out in prior instances.  "It's a reasonable guess that the next time the 20-wma is tested, it will break and SPX will complete its full retest of the February low. It's also a good guess that a trip to the lower Bollinger is in store for 2018. The long uptrend in 2013 weakened in 2014 and ultimately broke at the end of that year."(See Chart Below)  If he is right and the S&P doesn't hold the 20 week moving average we could be heading to the lower bollinger band around 2550 which would bring in a test of the February lows. 




Since the February 9th bottom, performance has been led by tech and financials.  However, if we break down the performance among S&P sectors over the last month we can see an interesting trend.  Technology still leads the way as the dominant sector as we discussed above but the second biggest move has been utilities.   This has a defensive undertone.


If we turn our attention to the monthly BAML survey to get a read on fund managers sentiment and positioning it can confirm some of our own findings.  The most crowded trade is long FANG stocks while short volatility slips to sixth from 1st in January.  At the same time, March rotation shows investors reducing risk by increasing defensive allocations.  Not surprising, threat of a trade war is back as the biggest tail risk for fund managers overtaking inflation.  74% of investors now believe the global economy is in "late cycle", the highest on record.  Respondents think 3.6% is the "magic number" to cause investors to rotate from equities back into bonds while 58% of FMS investors think global corporate earnings will rise 10% or more over the next 12 months. 








The market sits at an important juncture after rallying off the February lows.  The next few days and weeks will go a long way in determining the direction of the trend.  If the downside of the wedge pattern and the 20 week moving average give way it could set up a test of the February lows.  If the market holds current levels and breaks to the upside there could be a sprint to new highs that catch traders flat footed.  For the trend to resume higher it will need to be accompanied by breadth and broader sector participation outside of technology.  With expectations that earnings will continue to grow we believe any pullbacks should be well contained.  However, considering the highest recorded reading of investors believe the global economy is in the late cycle phase we still expect to have bouts of heightened volatility.  Tomorrow's FOMC meeting will give us plenty to talk about with regards to the economic outlook, bond yields, trade wars, and the Fed's positioning.