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Bullish or bearish? What’s your time horizon?

Summary:
Mid-week market update: The midterm election performed roughly as expected. The Democrats regained control of the House, and the Republicans held the Senate and even made some gains. Is this bullish or bearish for equities? It depends on your time frame. Here is my outlook from a strictly chartist’s viewpoint, starting with the long-term to the short-term. From a very long-term perspective, the negative monthly RSI divergence and MACD sell signal is too worrisome to be ignored. These conditions suggest that the market is making a broad-based top. The latest MACD sell signal is unlikely to be resolved with a minor 2015 style correction. The technical breach of the relative performance of bank stocks, which was accompanied by a similar relative support violation of the regional banks,

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Mid-week market update: The midterm election performed roughly as expected. The Democrats regained control of the House, and the Republicans held the Senate and even made some gains. Is this bullish or bearish for equities? It depends on your time frame.

Here is my outlook from a strictly chartist’s viewpoint, starting with the long-term to the short-term.

From a very long-term perspective, the negative monthly RSI divergence and MACD sell signal is too worrisome to be ignored. These conditions suggest that the market is making a broad-based top.

Bullish or bearish? What’s your time horizon?

The latest MACD sell signal is unlikely to be resolved with a minor 2015 style correction. The technical breach of the relative performance of bank stocks, which was accompanied by a similar relative support violation of the regional banks, is another warning that a major decline is under way.

Bullish or bearish? What’s your time horizon?

That said, nothing goes up or down in a straight line.

Prepare for the year-end rally

However, intermediate-term indicators are sufficiently oversold to expect a relief rally into year-end. The normalized equity-only put/call ratio was highly stretched and it has begun to mean revert, which is a classic buy signal.

Bullish or bearish? What’s your time horizon?

There are other signs that risk appetite is recovering. Emerging market stocks, which have been badly beaten up in the latest downturn, have begun to show some signs of life. EM equities (EEM) compared to the MSCI All-Country World Index (ACWI) have rallied through a relative downtrend. The performance of the other major components show that all regions, except for China, are showing signs of relative strength.

Bullish or bearish? What’s your time horizon?

There is much evidence that stock prices perform well after midterm elections. Here is one example of the historical pattern from CNBC.

Bullish or bearish? What’s your time horizon?

However, I would temper those expectations by pointing out that there are many ways of analyzing the historical data. The same CNBC report showed that Fundstrat found equities perform well only when House control remains unchanged, which is not the case in 2018.

Bullish or bearish? What’s your time horizon?

In the last 100 years, Ned Davis Research found that the combination of a Republican president and a split Congress occurs about 10% of the time, and the DJIA’s annualized return is -6.1% during those instances.

Bullish or bearish? What’s your time horizon?

Short-term overbought

In the very short-term, the market was already at overbought extremes as it approached election night Tuesday. Conditions are going to be even more extended after Wednesday’s rally.

Bullish or bearish? What’s your time horizon?

Rob Hanna at Quantifiable Edges did not find a short-term trading edge after the midterm elections, except for a one-day rally after the election.

Bullish or bearish? What’s your time horizon?

The most likely short-term scenario for the market is it chops around a bit more, as the Fear and Greed Index did during past W-shaped bottoms.

Bullish or bearish? What’s your time horizon?

In conclusion, how you should behave is a function of your time horizon. The stock market appears to be making a broad-based top, but it is also in the process of making an intermediate bottom, and a year-end rally is likely. Tactically, however, stock prices are highly overbought and will probably pull back and possibly test the recent lows. At a minimum, expect one or both of the gaps below to be filled first before the the market can mount a sustainable rally.

Bullish or bearish? What’s your time horizon?

Disclosure: Long SPXU

About Cam Hui
Cam Hui
Cam Hui has been professionally involved in the financial markets since 1985 in a variety of roles, both as an equity portfolio manager and as a sell-side analyst. He graduated with a degree in Computer Science from the University of British Columbia in 1980 and obtained his CFA Charter in 1989. He is left & right brained modeler of quantitative investment systems. Blogs at Humble Student of the Markets.

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