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Waiting for the breakout

Summary:
Mid-week market update: It’s difficult to make a coherent technical analysis comment on the day of an FOMC meeting, but the stock market remains in a holding pattern. While the S&P 500 remains in an uptrend (blue line), it has been consolidating sideways since late November and early December.  Until we see either an upside breakout or downside breakdown out of the trading range (grey area), it’s difficult to make a definitive directional call either way. The bull can point to a brief spike of the VIX above its upper Bollinger Band on Monday, which is a sign of an oversold market. TRIN also rose to 2 on Monday, which can be an indication of panic selling. As well, the VIX Index is normalizing relative to EM VIX since the election. The US market has stopped acting like an emerging

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Mid-week market update: It’s difficult to make a coherent technical analysis comment on the day of an FOMC meeting, but the stock market remains in a holding pattern. While the S&P 500 remains in an uptrend (blue line), it has been consolidating sideways since late November and early December.
 

Waiting for the breakout

Until we see either an upside breakout or downside breakdown out of the trading range (grey area), it’s difficult to make a definitive directional call either way. The bull can point to a brief spike of the VIX above its upper Bollinger Band on Monday, which is a sign of an oversold market. TRIN also rose to 2 on Monday, which can be an indication of panic selling. As well, the VIX Index is normalizing relative to EM VIX since the election. The US market has stopped acting like an emerging market as anxieties have receded. As the S&P 500 tests the top of the range, these are constructive signs that the market is about to rise. On the other hand, the bears can say that even with all these tailwinds, the stock market remains range-bound and unable to stage an upside breakout, indicating that the bulls are having trouble seizing control of the tape.
 

Signs of consolidation

The market is definitely showing signs of consolidation. The Vaccine Monday rally of November 9, 2020 marked a turnaround in risk appetite and factor leadership. Since then, small caps and value stocks have led the way. These “Great Rotation” groups gapped up on Vaccine Monday by exhibiting runaway gaps and haven’t looked back since. 
 

Waiting for the breakout

The dotted lines in the chart above depicts the relative performance of each of the groups relative to the S&P 500. Both large cap value and small cap value have started to trade sideways relative to the market in the past few weeks. Only small caps have continued their outperformance.
 

These are signs of consolidation and a market digesting its gains.
 

A bearish tripwire

What’s next? One of the bearish tripwires that I outlined on the weekend (see Time for another year-end FOMO rally?) has been triggered. The low-quality small cap Russell 2000 is outperforming the high quality S&P 600. This is an early warning of a correction, especially in light of the highly extended nature of sentiment readings. However, the low quality factor signals of impending weakness have tended to be early in the past. Large cap quality are still performing well. These conditions are not an immediate cause for concern.
 

Waiting for the breakout

In the short run, the market is enjoying some seasonal tailwinds. This is option expiry week, and Rob Hanna at Quantifiable Edges found that December OpEx week has historically been bullish.
 

Waiting for the breakout

As well, seasonal patterns have tended to be bullish this time of year. I see few compelling reasons why this year would be an exception.
 

Waiting for the breakout

I interpret these conditions as a market poised for a year-end rally into January. Enjoy the party, but watch out for the hangover in a month.
 

Disclosure: Long SPXL
 

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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