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“This rally is crazy, it can’t keep going on!”

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Troy
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Summary:
The S&P is now almost at its 200 day moving average. After a very rapid decline in December 2018, the stock market is making an equally rapid rally right now. Extremes happen in both directions. This has been a V shaped recovery. Go here to understand our fundamentals-driven long term outlook. Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day. *Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future. V shaped recovery The stock market’s recovery has been V-shaped. With the risk of sounding like a broken record, most of these V

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The S&P is now almost at its 200 day moving average. After a very rapid decline in December 2018, the stock market is making an equally rapid rally right now. Extremes happen in both directions.

This has been a V shaped recovery.

“This rally is crazy, it can’t keep going on!”

Go here to understand our fundamentals-driven long term outlook.

Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

“This rally is crazy, it can’t keep going on!”

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

V shaped recovery

The stock market’s recovery has been V-shaped.

“This rally is crazy, it can’t keep going on!”

With the risk of sounding like a broken record, most of these V shaped recoveries are followed by a pullback/retest

The S&P 500’s 27 day rate-of-change has gone from less than -13% to more than +11%.

Historically, this has been more bearish than bullish for stocks over the next 2-3 months

“This rally is crazy, it can’t keep going on!”

“This rally is crazy, it can’t keep going on!”

This is a line oft repeated by bears.

Yes, the rally is crazy.

Yes, it is likely that the stock market will make a short term pullback/retest.

However, not all “crazy rallies” are followed by a pullback or retest. Most are, but not all.

This is why we repeat “focus on the medium-long term, and mostly ignore the short term”.

For example, the S&P has been above its 10 day moving average for 21 consecutive days, while still under its 200 day moving average.

“This rally is crazy, it can’t keep going on!”

Historically, this has been bullish for the S&P 1-2 months later. Perhaps the S&P will come close to making an all time high before making a pullback retest, as we mentioned this weekend.

“This rally is crazy, it can’t keep going on!”

As per a popular Market Watch article, the NASDAQ has cleared away from “bear market territory” (define by the traditional -20% line).

The NASDAQ was more than -20% below a 2 year high, but is now less than -10% below a 2 year high

“This rally is crazy, it can’t keep going on!”

Historically, the NASDAQ’s 2 month and 1 year forward returns were remarkably bullish.

“This rally is crazy, it can’t keep going on!”

2 year Treasury yield

The 2 year Treasury yield made a “death cross”, whereby its 50 day moving average fell below its 200 day moving average.

“This rally is crazy, it can’t keep going on!”

“This rally is crazy, it can’t keep going on!”

While most traders are “worried about the Federal Reserve’s rate hikes”:

  1. Rate hikes are more bullish than bearish for stocks. The Fed hikes rates when the economy is improving, which is long term bullish for stocks
  2. Rate cuts are more bearish than bullish for stocks. The Fed cuts rates when the economy is deteriorating, which is long term bearish for stocks.

*The Fed reacts to the economy. The economy is the real determinate for long term stock prices.

Interest rates are falling right now, while the Unemployment Rate is creeping up. This is not a good combination.

Here’s what happens next to the S&P when the 2 year Treasury yield made a “death cross” while the Unemployment Rate is above its 12 month moving average.

“This rally is crazy, it can’t keep going on!”

You can see that with the exception of 1995, all of these historical cases happened within the context of a bear market or economic recession.

Earnings season reactions

Here’s an interesting chart from Bespoke, which demonstrates that stocks have reacted positively to earnings reports this earnings season.

“This rally is crazy, it can’t keep going on!”

In fact, this is the most positive reaction since Q1 and Q2 2009, at the bottom of the 2007-2009 bear market.

On the surface this seems like a long term bullish sign for stocks, but I would like to see more historical data before jumping to any conclusions.

Baltic Dry Index

The Baltic Dry Index measures dry bulk shipping stocks. It is frequently used as a measurement for global shipping, an economic bellweather. (The common belief is that more shipping = improving global economy, less shipping = worsening global economy.)

The Baltic Dry Index has collapsed recently, reflecting the global economic slowdown. This global slowdown is much more pronounced outside the U.S. than within the U.S.

“This rally is crazy, it can’t keep going on!”

Is this a long term bearish sign for the stock market and economy?

Here’s what happens next to the S&P when the Baltic Dry Index is more than -50% below its 200 dma

“This rally is crazy, it can’t keep going on!”

This is neither consistently bullish nor bearish for stocks.

Extremely strong breadth

Breadth remains extremely strong thanks to the stock market’s nonstop rally. The NYSE McClellan Oscillator (a breadth indicator) remains above 50 for 21 consecutive days.

From 1998-present, this has never happened before.

“This rally is crazy, it can’t keep going on!”

Overbought

The S&P 500’s 14 day RSI is approaching “overbought” territory for the first time in a long time. Is this bearish for stocks?

“This rally is crazy, it can’t keep going on!”

Here’s what happens next to the S&P 500 when its 14 day RSI exceeds 65 for the first time in 4 months

“This rally is crazy, it can’t keep going on!”

Neither consistently bullish nor bearish for stocks on any time frame.

“This rally is crazy, it can’t keep going on!”

Gold is also overbought

It’s not just the S&P that’s overbought. Gold is overbought as well. As of last Friday, gold’s RSI reached 70 for the first time in 2 years.

“This rally is crazy, it can’t keep going on!”

Here’s what happens next to gold when gold’s 14 weekly RSI exceeds 70 for the first time in 1 year

“This rally is crazy, it can’t keep going on!”

Gold’s forward returns over the next 3 months are bearish. Even if this is a new gold bull market, bull market’s don’t often go up in 1 straight line.

Defensive sector

We continue to monitor defensive sectors’ underperformance as the broad stock market rallies.

“This rally is crazy, it can’t keep going on!”

The S&P has gone up more than 9% of the past 25 days, while XLU has gone up less than 4%.

“This rally is crazy, it can’t keep going on!”

You can see that many of these historical cases are an overlap. But either way, this is the normal price action around 15%+ declines or bear markets.

“This rally is crazy, it can’t keep going on!”

Click here for yesterday’s market study

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction (i.e. next 3-6 months) is neutral. Some market studies are medium term bullish while others are medium term bearish
  3. The stock market’s short term has a bearish lean due to the large probability of a pullback/retestFocus on the medium-long term (and especially the long term) because the short term is extremely hard to predict.

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.

“This rally is crazy, it can’t keep going on!”

Our discretionary outlook is not a reflection of how we’re trading the markets right now. We trade based on our quantitative trading models.

Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.

Click here for more market studies

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