2018 has marked a very interesting year for the stock market. After a year of practically uninterrupted increases in stock prices in 2017, where every small dip in price provided a new opportunity to jump back in and made the market look like easy money, 2018 has been anything but predictable. Geopolitical concerns like Brexit, trade tensions between the U.S. and its largest trading partners, and speculation about the sustainability of historically low interest rates and global economic health have all had their day in court.
The trade war between the United States and China seems to finally be making some positive headway, and any kind of substantive compromise between the world’s two largest economies should naturally be taken as a positive for long-term growth. Even so, pessimists point to a number of issues that loom as ongoing risks that threaten to plunge not only the U.S., but the global economy into recessionary conditions. Some analysts predict that could come sometime in 2019, which others point to the latter half of 2020.
What are the risks? Many of them seem to be self-imposed; at the end of last year the Trump administration, and the Republican party pushed through tax cuts for individuals and businesses that have provided a significant, almost immediate increase in corporate profits that many economists have argued wasn’t really necessary since the economy was already chugging along with healthy, albeit modest long-term growth figures. That tax cut naturally increased deficit spending by the government.
Interest rates are another intriguing concern. Any talk about increasing interest rates over the last decade has put investors on edge, and it is true that the Fed has been raising rates since late 2015; but the pace of those increases has been so gradual that even now they remain at historically low levels. I was intrigued this morning by one report I saw that showed the historical average rate for the 30-year Treasury bond at around 5%, while the rate now sits at around 3.13%. Investors lately have been speculating that economic indicators showing U.S. economic growth is slowing mean that the Fed might be able to lessen the pace of their rate increases even more than they have been doing. The concern, however is that the Fed is trying to “thread the needle” between keeping rates high enough to keep inflation from growing too quickly and staying low enough to keep the economy growing. It’s a balancing act the Fed has tried time and time again to do – and time and time again has failed to accomplish.
Trade tensions, despite their progress, remain a risk. After President Trump announced that the U.S. and China had agreed to a temporary pause in adding more tariffs to the current conflict, the market cheered, only to turn around a couple of days later when news broke that the CFO of Chinese tech giant Huawei Technologies had been arrested in Canada and will be charged by the U.S. for violations of sanctions against Iran. If the past year has taught us anything about this particular American president, it is that his idea of trade negotiation and diplomacy is radically different than what anybody on the Hill, or even in the market is used to. That means that the path to trade peace is likely to remain rocky, and could still fail completely.
As an analyst, it can be daunting to pay attention to all the news and filter through the noise the market shifts its attention at any given moment. That’s one of the reasons that I think it’s important to use technical analysis to look at the market’s action over time; the patterns that emerge can offer insight that helps to put the noise into a constructive context. Today I took some time to look over the long-term trends for the S&P 500 as a measurement of broad market activity and think about what has happened over the past year. What I’ve found is interesting, and I think it puts some perspective on some of the hand-wringing I’ve been hearing about recently from other analysts. Let’s take a look.
This is a chart that covers the last two years of the market’s activity, and I used that time frame because it gives a good look at the strength of the market’s long-term trend running all the way into the beginning of this year, which I’ve highlighted with the purple dotted line. The market hit a hard stop in mid-January before plunging back a little over 10% to its 52-week lows in February and April.
One of the interesting principles of trend analysis that has demonstrated itself repeatedly throughout the history of the stock market is the “last gasp” rally that usually punctuates the end of a long-term bullish trend. Inevitably, a long trend will reach a peak and start to drop back and show some broad market weakness; but what seems to happen almost every time is that investors eventually decide the drop is yet another opportunity to “buy the dip.” That usually pushes the market to a new-all time high, and it often gets a lot of people talking about how strong the stock market has been and should continue to be, and how easy it really is to make money by investing in stocks. The average, mostly uneducated investor usually gets sucked in at this stage, which is part of the reason the market is able to stage a brand new push to all-time highs; a lot of money comes off of the sidelines and buys in at the top of the trend.
The S&P 500’s rally shown above from April to September of this year to me looks an awful lot like a “last gasp” rally. These final pushes can cover several months at a time, and it’s interesting that while the market broke above its January high in August, the pace of the market’s increases clearly started to taper off until early September, when renewed concerns about trade and the broad economy gave institutional investors reasons to start taking profits and moving to the sidelines.
Over the last few months, I’ve been watching the 2,600 level for the S&P 500 as an important inflection point for the market’s overall tone. That level is right around the lows the market reached in February and April, and it’s true that the market has still not broken below that level yet. That could be taken as an indication that the market could remain bullish for the foreseeable future, and I do generally agree with the idea that a market correction isn’t categorically bearish; in fact more often than not they are a positive for the overall health of the economy and the market and help it to maintain its longer-term upward trends. On the other hand, I also think that the market is starting to show another bearish warning sign in the trading range I highlighted on the far right of my chart with the horizontal, red and green dotted lines. The fact is that during its rallies for the last three months, the index has consistently failed to move above the resistance show by the dotted red line. On a day to day basis, the market remains quite volatile, but this narrowing range between support and resistance, below the January high point could be an important indication not only that bullish momentum is fading fast, but that bearish sentiment is building.
I’m still watching the 2,600 level for the index as an important support level; but I think the market’s latest technical view shows that risk of a break below that level, and to extend its latest correction possibly into bear market territory, is increasing. That means that you should be very careful and cautious about taking on new positions right now.