It's 1998, not 1987

February 16, 2018 02:11 PM

As noted in all of our recent analysis, the fundamental backdrop was just not consistent with any orderly push higher in U.S. interest rates triggering a sharp reversal of the U.S. equities' major bull trend. Of course, that still meant after the U.S. 10-year T-note yield swung above its 2.62% four-year high back on Jan. 19 (incidentally the same day as our Showdown at Govvies Graveyard post) the higher interest rates might disrupt the U.S. equities’ runaway upside (parabolic rally) psychology. Even though that took until yields pushed still higher (2.70%) into Jan. 29, the potential for a sharp reaction was always there after the U.S. equities bull move became such a straight up affair.

And react it did, with a vengeance. Yet, the acceleration into the extended January rally also raised the commensurate lowest ‘idealized’ up channel support. That was based on the higher (topping line that sets the trend vector) and lower (projected parallel) major channel support line obvious from before the depths of the sharp selloff, as shown in the opening two-year front month S&P 500 weekly chart.  Yet a real trend reversal would have required a DOWN Break (i.e. weekly Close) last week not only below that 2,575 channel support, but also below the 2,545 weekly MA-41.   

As explained in an emailed note to Rohr-Blog subscribers last week Wednesday, “…even though we believe the U.S. equities remain bullish, we would be cautious until the key lower levels are at least neared, or possibly fully retested.” That was based on “…markets which trade rapidly into a key area and reverse outside of Regular Trading Hours (RTH) tend to want to revisit those key levels in subsequent RTH trading…” and can still be good as long as those key levels are held.

This is why last week’s Thursday-Friday drop was not a confirmation of a more dire U.S. equities failure into a "crash." That was especially so once it recovered strongly from the midday Friday lows.

Critical secondary consideration

Yet there is a critical secondary consideration which must always be fulfilled in those cases on the need to extend the bull rally recovery once again above higher resistances in order to reinforce the initial basing tendencies. That meant the need to recover back above the 2,660 higher intermediate-term channel down break, as that higher channel became the clear next critical resistance area as seen on the chart provided via Rohr-Blog last week (below.)

Courtesy of All International Rights Reserved.

Then this week’s further rally from successfully holding Friday’s retest of last week’s early (non-RTH) 2,529 trading low saw Monday’s test of the 2,660 area (and even a bit higher.) Tuesday turned into a quieter consolidation day prior to the anticipated major influence from Wednesday’s economic releases. While there was no new high for the rally, the nominally higher March S&P 500 future close was right in the 2,660 area.

Then overnight into Wednesday morning it was trading 15 points higher (in the electronic Globes trade) prior to Wednesday morning’s pre-opening stronger than expected CPI data weighing on govvies (i.e. higher interest rates) immediately knocking it down to roughly 30 points on the day (still prior to the RTH opening.)

Of course, the importance of that was the subsequent degree to which U.S. equities were able to shake off the influence of those higher interest rates to push higher on the day. That was not just due to the strength to push higher at all, yet also the degree to which the March S&P 500 future was indeed exceeding (i.e. negating) that 2,660 higher channel down break.

That sets the stage for an overall return to a more bullish trend, and shifts the lower support up to the area of the 2,660 Negated DOWN Break. While there are quite a few higher interim resistances, as long as it holds the 2,660 area the mid-low 2,800 area is likely to be retested over the near term regardless of how the ultimate trend unfolds. 

Time correction

Does this mean U.S. equities are back on a fully bullish track with anticipation the front month S&P 500 future might exceed the late January 2,878.50 all-time? Or might they stall short of the high as part of forming a top, with the bull move essentially over except for the filling out into that top? The answer is, “Yes.” Either might be the case.

What we know is that after such a parabolic trend extension in January, the market is entitled to a breather. And from a trading perspective, that point is moot: from current levels expect that the 2,660 area is now support, and the market will rally back up into the low-mid 2,800 area prior to stalling.

Quite a few folks (and especially some technical trend analysts) are primarily focused on the extent (amplitude) of any ‘price’ correction. That can be in percentage terms (like Fibonacci retracement levels), longer-term trend momentum indications (like long-term moving averages, such as our weekly MA-41 proxy for the more widely followed daily MA-200), or the trend and channel projections like the ones on the charts above.

However, experienced analysts also know that especially after a particularly significant accelerated trend, markets are more likely to go into a consolidation phase across ‘time’. While there are rare cases where a subsequent large trend extension comes directly in the wake of only a very slight pause, for the most part looking for the next "big move" directly in the wake of the end of a recent major parabolic price swing is misguided.

Many factors discounted

The received wisdom on the ‘macro’ market psychology is that the previous major swing likely discounted quite a few countervailing fundamental influences to maintain the torrid pace of that major trend. Think about how many days the front month S&P 500 future shook off nominally negative near-term fundamental data or news to sustain the tax-reform driven overriding bullish psychology; including the growing sense that the better U.S. (and global) economy was indeed going to push interest rates higher.

And outside of U.S. tax reform’s clear indication that there will indeed be higher retained (i.e. after tax) corporate earning’s, nobody really knows how much more profit that will leave at the bottom line. And that’s the basis for the (long term) key p/e (price/earnings) ratios that indicate whether stocks are still a value.

So it is reasonable to expect a technical tendency for the U.S. equities to now enter a ‘time correction’ until matters clarify. That is especially in light of some sporadic weaker U.S. economic data of late, even if that is still overridden by the general upbeat psychology that will assist the U.S. equities in rallying from no worse than recent lower levels. 

While this doesn’t mean a new all-time high is guaranteed, it does point toward at least a price swing back up near the January highs into the low-mid 2,800 area. That is likely the least the market will accomplish whether it is part of forming a broader top that may ultimately reverse the bull trend, or it is a large consolidation range that will allow a future push to a new all-time high.

And it is very hard to tell the difference along the way during the formative phase of the ‘time correction’. While some folks will refer to volume tendencies and other subtle indications, the ultimate signal only comes with a violation of the highs or a drop back below recent lows.

The 1998 versus 1987 difference

So how is it that we can be so confident that U.S. equities, with the front-month S&P 500 future roughly 150 points below its January high, are not going to revert to a far more bearish condition which will end in a 1987-style crash? The macro-technical answer begins with ‘macro’ assessment reviewed in our last Weekend: The ‘Demand-Pull’ Bond Bear post for current conditions. The good reason the govvies are bearish is the synchronized global economic recovery calls for higher interest rates.

When they get high enough, they can indeed draw capital away from the equities. Yet they are not even high enough in the U.S., let alone other major economies with very low rates (Euro-zone, UK, Japan) to even begin to believe that is happening anytime soon. This is distinctly different than 1987 when U.S. 10-year yields had climbed from roughly 7.00% to near 10.00% out of January into the October month of the Black Monday crash.

And recently U.S. companies’ price/earnings ratios have become more reasonable even as the equities have climbed. That is due to the tax reform-driven higher retained earnings estimates for later this year.

Page 1 of 2
About the Author

Alan Rohrbach is Lead Analyst and President of Rohr International, Inc.  He is an international equity index, interest rate and foreign exchange trend advisor. His forte is ‘macro-technical’ analysis of how fundamental influences blend with technical aspects to drive trend psychology. Clients include international banks, hedge funds, other portfolio managers and individual traders.