The S&P 500 fell 4.6% to close at 2,633 this week (ending Dec 7th 2018). Investors got what they were looking for in the last 2 weeks …

  • A federal reserve indicating that they may change to a ‘wait and see’ approach for next year before raising interest rates – this is a positive for stocks.
  • China/US trade war fears were eased somewhat when President Trump and President Xi agreed a cease fire on the trade war front for 3 months.

Markets rallied on Monday on all of this news breaching 2,800 for a brief time. So what went wrong? We believe it is a combination of 3 catalysts:

  1. Huawei – The arrest of Chinese company Huawei’s CFO Meng Wanzhou (the CEO’s daughter) caused panic in Global Stock Markets. Arrested in Canada on Dec 1st (the day Trump and Xi agreed the trade war ceasefire) with a view to being extradited to the US. She is charged with fraud and breach of US trade sanctions with Iran. The UK have come out in support of the US. However, China branded it a breach of human rights. Traders are now fearing the trade ware ceasefire may fall apart.
  2. Inverted Yield Curve – The middle part of the yield curve is inverting. The 2 year US bond is offering a higher interest rate than the 5 year bond. Inverted yield curves usually signal pending problems for an economy – however this is not confirmed yet. As both the 10 year and 30 year are still offering higher rates. Nevertheless it has given traders something else to worry about.
  3. Trading Algorithms – This is were buy and sell orders are being submitted to the financial markets by software programmes when certain criteria is being met such as inverting yield curves (as mentioned above) and technical indicators being broken. The volume of orders coming from these algorithms is a real issue for global stock exchanges as they cause flash crashes which then give further sell signals and then the spiral continues. In our view, any stock market falls due to trading algorithms can be seen as an opportunity to buy if fundamentals are sound. Nevertheless, this has caused major fear for the investors.

There is one thing that does not appear to be making sense. The velocity of the selloff would normally show a huge jump in the VIX (the investor fear gauge). Whilst the VIX did rise to 23 it is nowhere near the levels you would normally associate with such volatility. For example, when the Brexit vote came in the VIX jumped to 50, earlier this year in February the VIX spiked to 50 and in volatile trading times the VIX is at 30.

This suggest one of two things to me – that the stock traders have got this wrong and a relief rally maybe imminent or the option traders are not measuring the risk appropriately. We will find out this week who was right or wrong!

Let’s have a look at the charts.

Support & Resistance:

support and resistance

Chart of S&P 500

The S&P 500 broke and closed below the 2,700 level this week at 2,633. The 2,700 level becomes resistance 1. Bears will be delighted this week to see how easy numerous support areas were breached. Bulls will get some encouragement that support above 2,600 wasn’t breached.  

The sideways trend of 2,600 to 2,800 remains in tact. However, any negative retaliation from China to the Huawei CFO arrest may cause markets to break below support. On the flip side any signal from China that they will not retaliate is likely to be met with a big relief rally.

For now 2,600 to 2,800 is still the likely trading range based on support and resistance. .

Moving Averages:

S&P 500 Moving Averages

The S&P 500 index is currently trading at 2,633. All moving averages are acting as resistance right now:

  • the 10 day moving average (red line) 2,704
  • the 20 day moving average (yellow line) 2,711
  • the 200 day moving average (green line) at 2,761
  • the 50 day moving average (purple line) at 2,758

Bulls will be concerned with the 50 day moving average crossing below the 200 day moving average. This is known as the ‘death cross’ and is usually a bearish signal (but not always).

Bollinger Bands:

Bollinger Bands

S&P 500 Bollinger Bands

Bollinger Bands are indicating a range of between 2,612and 2,811. The index has reverted below the mean 2,711. If support holds, this indicates that a bullish reversal is possible to at least the 2771 level and as high as 2811

Note About Bollinger Bands: Please complete the technical analysis course to understand the benefits and limitations of Bollinger Bands.

Stochastics:

Stochastics

S&P 500 Stochastics

Stochastics have now reversed from overbought levels and are heading quickly to the oversold area (though not quite there yet). This indicates that there maybe some more pain left to the downside but we may get to the bottom of this selloff quite soon.

A drop below the 20% line and rise again above it would be a bullish signal. But beware, stochastics can stay oversold for quite some time. Be patient and wait for the buy signal.

Note: Remember, Stochastics only work well in sideways trending markets.

Technical Summary:

  • Bears are back in control for now with only the 2,600 level acting as support.
  • The trading range of 2,600 to 2,800 still holds.
  • Bollinger Bands are indicating that a bullish reversal maybe imminent.  
  • Stochastics are indicating that there maybe some more downside yet but a bottom maybe imminent.

From a technical perspective, expect the market to fluctuate between 2,600 to 2,800 until either level is broken and at least 3 trading days above or below those levels.

Overall Market Outlook:

  1. Technical – Sideways for now between 2600 – 2800.
  2. Earnings – Investors are now pricing in peak earnings. This doesn’t mean that earnings are bad, it simply means that companies will not grow at the same rate as they have done this year. This had to be expected as the sugar high from the Trump Tax cuts fade away.  
  3. Valuation – We believe that the S&P 500 is now priced below fair value. We believe that it will trade somewhere between 2500 and 3000 over the next 12 months. We see great opportunities at these levels.
  4. USD & Bond Yields – The USD head steady this week. The 10 year year yield dropped to 2.85%. That was a big drop this week and clear indication that traders believe the FED will pause raising rates after the December rate hike. This can be seen as a positive and negative for the stock market:
    • Positive: In that the lower yield will make stocks more attractive
    • Negative: Why is the yield dropping so fast – are investors fearing a recession around the corner?
  5. Trade Wars – The China reaction to the arrest of Huawei’s CFO will be a major catalyst for the stock market this week – good or bad. A neutral reaction will most likely result in a rally but any hint of a return to trade wars could signal another leg down – this is the most important story in the stock market for now.
  6. Recessionary Risk – 2020 is now being talked about a lot as a mild recession in the US. Stocks normally price this in about 6-9 months in advance. If this holds true, then expect a selloff to start early to mid 2019. For now, it is not on the agenda.

In summary, if the trade war fears subside we could get a relief rally in this market which drives the S&P 500 index as high as 2800. On a fundamental level this market could range between 2,500 and 3,000 over the next 12 months. The rise in volatility allows us to take positions in the market and get paid substantially for purchasing stocks at much lower prices.

Invest wisely!

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Happy Investing

The Team at Share Navigator