by Jeffrey Saut
Retests, Recessions, and Rallies
January 14, 2019
Recently, much has been written, and said, about a retest. The reference is about the major indices pulling back to their recent December closing lows, creating a double-bottom in the charts. In the case of the S&P 500 (SPX/2596.26) that would mean a pullback and retest of the December 24, 2018 closing low of 2351.10. As often written, our sense is that is not going to happen given the sequence of events the equity markets have been through over the past three months. Moreover, as we have also written:
You know we came into 2018 in full bullish mode with WAY too many bulls and everyone expecting the 2017 "bull run" to be repeated in 2018. This year we came into 2019 with WAY too many bears believing the equity markets are going to crash. Folks, last January the Fed was in tightening mode while investors were wildly bullish. This year the Fed appears to not be in that mode and investors are wildly bearish.
Speaking to all the talk about the U.S. falling into recession, I see no evidence that will occur anytime soon barring some kind of black swan event. Many recession pundit predictors point to the yield curve, referencing an inversion of the 2-year T'note to the 5-year T'note, or the 2-year T'note to the 10-year T'note. To us, these are the wrong yield curves. During our 48 years in this business the correct yield curve has always been the 90-day T'bill to the 30-year T'bond and it is nowhere near inversion. Junk bond spreads, while they have widened, remain tighter than they have been prior to recessions. The Leading Economic Indicators (LEI) have always peaked months before the start of a recession and the LEI is still rising. Household debt-to-disposable income has declined, incomes are rising, corporate balance sheets are strong, the Present Situations Index - which has telegraphed every recession - is still rising, and the list goes on. Accordingly, I just do not see why so many folks are thinking a recession is coming.
Turning to rallies, as previously written:
"You know we came into 2018 in full bullish mode with WAY too many bulls and everyone expecting the 2017 'bull run' to be repeated in 2018. This year we came into 2019 with WAY too many bears believing the equity markets are going to crash."
It feels to me like EVERYBODY sold in December looking for lower prices to put that money back to work. Typically, the equity markets are not that accommodative. My sense is prices are going to trade higher, forcing that sideline cash back into stocks into the end of January. And then, if there is going to be a pullback attempt it likely comes in February. Since the washout low in December there have been two 90% Upside Days, meaning 90% of the total up to down volume traded has come on the upside. Moreover, Advancing versus Declining issues has been strongly bullish with the same kind of 90% Upside Days, which resulted in a rare Upside Breadth Thrust. Further, the Buying Power Index is getting ready to cross above the Selling Pressure Index. Such a sequence usually implies the lows are in. As Lowry Research writes, "Overall, this combination of heavy selling followed by even stronger Demand appears to offer, according to the Lowry Analysis, a textbook example of a market bottom." It also strengthens my sense that we are in a "buying stampede." As often noted, such stampedes typically last 17 - 25 sessions with only one- to three-session pauses and/or pullbacks. If correct, today would be session 13.
My current thoughts on the equity markets were summed up better than I could write by the invaluable Bespoke Investment Group in their insightful weekly The Bespoke Report. To wit:
Santa was a few weeks late this year but the rally he eventually delivered after Christmas Eve lows is as strong as any rally he delivered during December of years past. Even more impressive than the uptick in equity markets has been the massive surge in credit, where spreads have plunged over the last two weeks. Bonds, loans, and everything else in sight has been hoovered up and helped to support the move upwards in equity markets. Adding to the tailwinds for the US specifically has been the easing off of pressure from the US dollar, interest rates, and perhaps ultimately the Federal Reserve. The Fed has taken a dramatically dovish turn in response to collapsing equity markets, slowing the pace it expects to tighten at this year. Interest rates have also fallen, driven by both the Fed and the risk aversion else-where in financial markets. As a result, housing activity is picking up and likely to keep doing so, giving a second negative feedback to market chaos that might otherwise cause a recession. When it's all said and done, it's not clear how fast the current pace of buying can continue, but earnings season brings a new focus for investors as it starts in earnest next week.
The call for this week: I thought the SPX rally from the December 24 "washout low" was likely going to run into the overhead resistance zone of 2600 - 2650. Last week's intraday "print high" was 2597.82, which did indeed stall the rally. We doubt the SPX can better that level in the short term. The S&P 500 Index formed an Outside Day on Thursday with a high of 2597.82 and low of 2562.02. There was not enough energy to push the S&P 500 index above 2600, so the S&P 500 had an Inside Day on Friday. Traders will be sensitive to the S&P's Friday high (2597.75) and low (2577.40) and even more reactive to the S&P 500's high and low from Thursday, which are breakout/breakdown levels. Speaking to "The Wall" and the recent Chinese trade talks, our DC-based Washington Policy analyst, Ed Mills, writes:
Putting the shutdown in the national spotlight did nothing to spark a deal between President Trump and Democratic lawmakers for border wall construction, and it appears that we are in the midst of the longest government shutdown in U.S. history, with the chances of a national emergency declaration significantly increasing. U.S.-China trade talks concluded in Beijing this week on a positive note and heightened optimism among administration officials that a deal can get done by the March 1 deadline. The next high-level talks will be key, and must sway the administration's skeptical China hawks.
This morning the preopening S&P 500 futures are off a large 26 points as China's exports shrink the most in two years and Britain's Brexit worries leap.
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