In this weekend’s review of the stock market, I will discuss both the bearish and bullish cases. An excellent case can be made for the bears. However, that case depends upon them showing up in force, which they have not yet done. And that does leave an opportunity for the bulls. So if we’re objective, and open to alternatives, we stand a better chance of participating profitably in the market. To that end, I will examine both sides today.
The basic view that seems most reasonable is that we just endured the fastest rate hiking cycle in history, and that the effects of that have not yet been fully felt by the economy, and so have not yet been priced in by the markets. And historically, hiking cycles often do work this way: the Fed hikes until they break something, then they pause and/or pivot, which signals that something broke, then the markets often enter the steepest, recessionary decline of a bear market.
We’ve already had a period of hiking, we then have had several banks fail, and so this pattern seems to be unfolding before our very eyes. So it would make sense if the rest of this scenario played out and we might then see the steepest, recessionary decline of a bear market. And to make matters even worse, we also now face the threat of a U.S. Treasury default, and who knows what something like that might do—if it happens. So from a story-telling point of view, the bear case is almost irresistible. Be that as it may, some stocks have performed really well lately, despite these headwinds, and since we can’t trade stories, and we must trade prices, we will also look at the bullish case as well.
The Bearish Case
The S&P 500 has been trading in a sideways range for weeks. In this last week, it’s managed to poke through the top of that range, and has even managed to close over the 89-week SMA:
This is not immediately threatening to the bears. At the August high, the S&P 500 closed over the 89-week SMA one week, but then closed back below it the next. And this failure produced a significant decline into the 2022 low. And furthermore, everyone already knows that sideways consolidations can be periods of distribution, and such events often end with a “spring,” a flush that clears liquidity over prior highs before a new leg down begins. So the strength last week on the S&P 500 remains entirely compatible with a bear market rally that is concluding with a pattern of distribution.
Now just because it’s compatible with a distribution doesn’t mean it is a distribution. For that, we’re just going to have to see if lower prices come along. If it is a distribution, and if institutions are selling into the strength here, things will turn lower, and a few very ugly things may be visible to us here if that happens.
On the Russell 2000, the long, sideways consolidation after the decline in 2022, can be treated as a kind of bear flag. And even within that, the smaller decline in the banking crisis in March has itself been followed by a smaller sideways consolidation that also may be interpreted as a bear flag. And so if one breaks down, it will cause the other to break down, and things will quickly look disastrous:
And likewise, on the NDX, IF it turns down here (and it might not), this can quickly take on the look of a large bearish wedge, consolidating over the trend line that has supported price since the GFC:
And so if a structure like this first forms, but then also breaks down, a disaster is coming.
I am not predicting that this will break down. First, prices need to turn down now and actually make this hypothetical structure. And then that structure also needs to break down. But if that starts to happen, we’re definitely groping our way towards a recessionary phase of a bear market.
If such a disaster strikes, here is how I would expect things to unfold from there, on the S&P 500, with some granular detail:
So that’s what I think will happen if things turn sour.
The Bullish Case
As enticing as the bear case is, the bullish case does have a few things here too. We are challenging the 89-week SMA on the S&P 500, and recapturing it and finding it as tested support would be a very strong signal that we’re not in any danger after all. There are a couple of other technicals I will also point out here.
The NDX had a very nice bearish divergence on the daily RSI developing. This recent squeeze has now broken that:
As with the Bear Wedge Maximus above on the NDX, if we turn down almost right this second, there will still be a new divergence present, but it will be much more mild:
But it will still be there, and so bulls can’t celebrate just yet.
Another technical that is constructive for the bulls is that the SPX daily has just produced a MACD bullish cross between the fast and slow lines:
That cross is one signal, among many. It can be promising for the bulls, but it’s not a lock. For starters, little short-term whipsaws on the MACD do happen, and there is still bearish divergence throughout these highs as well:
Divergence only tells us that momentum is slowing. That can happen at tops, where there is a change in trend, but it can also happen before momentum picks back up again, too. It is something to mindful of. It more often happens at tops because consolidations (bull flags, etc.) usually aren’t making higher highs in price. For instance, bull flags pull back. And it’s the higher highs in price, versus lower highs in momentum that cause the bearish divergence. But sometimes the market can coil in a way where it’s consolidating and also making new highs, in which case the divergence isn’t going to help. This is just a signal, and we need to keep an eye on it.
Another thing we have for the bulls is the sheer ridiculousness of the Nasdaq’s rally. In the Nasdaq’s history, it doesn’t have a lot of excellent, long-lasting bear markets for us to examine to see what they are “often” like. We have the dot-com bust, we have the GFC, those were nice and big. But much of the rest of its history involved a lot of flatter bear markets. However, in the dot-com bust, once it lost its 89-week SMA, it never got it back again until that bear market’s low was set in stone. That said, a recapture of the 89-week SMA in the GFC bear market did not coincide with the low being in. The signals here are mixed. And, like then, whereas the S&P has just barely nosed above its 89-week SMA, the NDX has punched far more strongly though its 89-week:
So, in the end, how the NDX responds to its 89-week SMA in bear markets is not as clear as with the SPX. In major bear markets, the SPX tends to lose its 89-week and keep it that way. At any rate, if the NDX can keep it, it should be good news for the bulls.
One last thing I have for the bulls is this. There are other world indices that are now making new all-time highs.
The FTSE already made a new all-time earlier this year, and now so has the DAX:
And so has the Nikkei:
These are now, no longer bear market rallies. This could be an excellent sign for the bulls. If the markets do turn sour, we can perhaps try to explain these events by looking to the fact that non-U.S. central banks maintained looser monetary policy for much longer than did the Federal Reserve. Otherwise, it won’t make a lot of sense for the whole world to rally to new highs in a recessionary bear market.
So we will need to keep an eye on these. Most of the world indices can also simply be forming double tops, so we will have to see. It’s not as if they’re rallying 20% above their prior highs. They’ve reached them, and we now need to see just how much resistance there is here.
If such a stick save ensues though, and the markets end up being ultimately bullish, here is how I would expect things to unfold from there, on the S&P 500, with some granular detail:
So that’s what I think will happen if things turn sweet.
The Unknowns
There are a couple of things I don’t know what to do with, so I will put them here near the end. At the beginning of this article, I said that historically, the Fed tightens until they break something, then they pivot, then we often get a recessionary bear market. I said “often” because that doesn’t always happen. We remember the times where this did happen because those were very dramatic. The dot-com Bust, the Great Financial Crisis, those sorts of times. But, there are exceptions.
One such exception is the late 80s to early 90s. There was a multi-year hiking/pause/pivot cycle that just kept leading to higher lows:
I understand that valuations were quite different back then. That’s why I’m not insisting on this. I’m only using it to show that not all hiking cycles end in catastrophes. I do think it would be ridiculous if we went up for a long time again today, like we did then. But, if we don’t break down and we don’t end up having a bad recession, any number of things are possible. I’m putting this in the “unknown” section because we don’t know what this hiking cycle is going to end up doing. It would make a lot of sense, given that it’s the fastest hiking cycle in history, for there to be consequences, but it’s been a period of unprecedented events these last few years, so it’s possible new precedents are again set ahead of us still.
One more unknown are bond yields. If we’re in a hiking/break something/pause/pivot cycle, it would help to know where we are within that cycle. And if the Fed is done hiking, yields of many durations should come down (the whole curve will move). And we should see that. And I’ve thought that’s a real possibility, and the market on and off has been trying to price in the same (even looking for rate cuts from time to time, despite the Fed’s insistence to the contrary). But, if the highs are in on yields, I’m not sure why we might be seeing this:
I have been pointing this bull flag out on the 10-year yield since early March. And it hasn’t yet broken out, hasn’t yet broken down. But it looks very good as a bull flag. So, if it breaks out, maybe they are not done with a hiking cycle or maybe something else is happening. So this is an unknown. If this breaks out, it can go to 5% or a little higher. Anyways, I don’t know what to do with it, but, we should watch it.
Some Final Things
I will end with 3 final things. They must also be watched closely.
Oil looks terrible:
Dr. Copper looks terrible:
Bitcoin looks terrible:
You can say “who cares” about Bitcoin, but if the commodities are making those structures in anticipation of lowered future demand, they might be pointing to the bearish, recessionary route. Given the sum of everything, I do favor the bearish case, but I will absolutely, positively, remain at least open to the bullish case in case some of these things improve—and they might. After all, we’ve all seen head and shoulders patterns, etc., squirt straight up in defiance of expectation.
[cough]:
I hope everyone finds something helpful or useful in this weekend’s article. Please like, and share the article if you enjoyed it.
I hope everyone has a wonderful weekend. And I will see you next week (or in the Discord if you’re in there this weekend).
Excellent, balanced work as always Dereck. Thank you!
You’re most welcome. We’re in for some big moves, I suspect, regardless. I do think down is more likely, but I won’t abandon the bulls just yet—just in case.