Oh dear. Ten trading days left in the year and things are looking grim. Last week’s 100 handle rip off of the Monday lows was sold again amid relentless fund outflows producing the lowest weekly close on $ES in 2018. Many sectors made new yearly lows including banks, transports and small caps. The 2009 bull market trend has either broken or is at the verge of breaking on many indices. $SPX on Friday closed the week over 13% below Wall Street’s 2018 consensus forecast with nearly 70% of its components below their 200 day moving averages.
All this right in front of the last FOMC meeting for the year. The stakes couldn’t be higher, hence my point on Friday:
Next week may be one of the most pivotal Fed meetings in recent memory.
Jay Powell will either be the new hero who saved markets or be blamed for what follows.
Tough spot to be in with no easy choices.
— Sven Henrich (@NorthmanTrader) December 14, 2018
All eyes then on a Fed that is staring at a potential shambles of a decade long intervention policy. Let’s not forget the context and history here which is critical for everyone to understand.
Since 2008/09 every major correction ended on central bank intervention, be it the Fed or global central banks:
And now that liquidity is drying up and the Fed’s QT program has accelerated the jig looks to be up.
Several key points to this chart:
Firstly the Fed’s own programs coincided with market bottoms in 2009, 2010, 2011 and 2012. QE3 ran through 2013 along with ZIRP. We had a taper tantrum along the way, but then the Fed started to slowly and cautiously raise rates and Janet Yellen’s planned 4 rate hike schedule for 2016 ended in February 2016 when she went dovish along with global central banks stepping in hard to avert the breakdown implied by the massive topping pattern that had formed. The aborted correction. $5 trillion in global central bank infusions followed giving the Fed the breathing room to recommence its slow hike schedule.
Note the 5 big topping patterns in the chart including the one we can see now. All on negative divergences as now. Every topping pattern led to a 20% correction or bear market, except one, the 2016 global intervention year. But all of these other patterns eventually reconnected with the weekly 200MA with most falling below. That MA currently sits at 2346 and hence, technically speaking, that’s at least where this correction should ultimately be heading, unless there is another miracle move via central bank action or jawboning.
But there are no central banks interventions now. Liquidity is being drained out of the system. The Fed is leading the way with its QT program which was accelerated this summer. Markets appear to not take it well. The ECB also confirmed it is ending QE at the end of December.
If this bull market was all about artificial liquidity then it should surprise no one that now a removal of liquidity is causing major problems. So perhaps the 10 year bull market was an artificial mirage far exceeding its natural organic equilibrium, a point bears have been making for years.
I have to repeat something I’ve said for a long time because it remains true: There is no evidence, zero, that markets anywhere can make and sustain new highs without some form of artificial liquidity flowing through them. 2018 still had tax cuts and record buybacks soaking through the system, but all that is waning now as well.
And it appears investors have gotten the message as they are selling. Hard:
And look closely at that state of markets right in front of this Fed meeting:
$SPX has currently broken its 2009 trend line. Only a big rally in the next 10 days can save the trend.
The industrial sector has broken its 2009 bull trend:
Transports are showing a weekly close below their 2009 bull trend:
And small caps are also sitting right at their trend as the underlying volatility trend has broken to the upside:
And the $DJIA is also hanging on for dear life:
And $SPX has now entered the upper risk zone I’ve been pointing to:
You get the message: The stakes for this Fed meeting couldn’t be higher. Markets are breaking or at the verge of breaking heading into this Fed meeting.
So what then is the prospect of a Fed inspired rally?
Historically speaking shockingly high actually. Check this out:
“We document that since 1994, the S&P500 index has on average increased 49 basis points in the 24 hours before scheduled FOMC announcements. These returns do not revert in subsequent trading days and are orders of magnitude larger than those outside the 24-hour pre-FOMC window. As a result, about 80% of annual realized excess stock returns since 1994 are accounted for by the pre-FOMC announcement drift. The statistical significance of the pre-FOMC return is very high; a simple trading strategy of holding the index only in the 24 hours leading up to right-before an FOMC announcement would have yielded an annualized Sharpe ratio of above 1.1. Other major foreign stock markets exhibit similarly large and significant pre-FOMC returns.”
Who is “We”? Well, if you think this is some random study I assure you it is not. This paragraph above comes to you courtesy of the Fed itself, specifically the NY Fed. And if you think this only applies to Fed easing cycles think again:
“The pre-FOMC drift is not significantly different in monetary policy easing versus tightening cycles“.
So you see, despite all the horrid action, selling and broken charts, the Bear Trap case is not dead yet. Indeed I could make the case for a rip your face off rally coming, both technically and structurally based.
Let me walk you through the evidence.
Note one sector chart I’ve not shown so far, the $NDX.
It’s still holding its 2016 trend line:
It’s also still holding its 2009 trend line:
Barely in both cases, but so far they’re still holding.
Now it gets interesting:
Its MACD is the most extreme since the 2000/2001 bubble burst making this correction actually more severe than 2016 and 2008/09. Ponder that.
Even during the 2000 bubble burst these type of readings resulted in massive counter rallies along the way.
Don’t forget $NDX is still remaining in a potential bullish wedge pattern:
Note the higher lows on the chart.
In context also consider the extremely tight wedge price pattern on $AAPL:
This pattern has room lower into the next large support zone on $AAPL, but it’s a very tight formation and a break higher could target MA reconnects.
Speaking of support, check the crushed banking sector:
It has entered critical support, is below its weekly Bollinger band and just above its weekly 200MA.
And while the month is not over have a look at what just happened with $USHL on a monthly basis:
The most oversold readings since 2008. No, this may just be a 10% correction on $SPX so far, the underlying stats show a much more severe correction underneath.
A couple of more charts to consider.
Every major market downturn has coincided with a turn in industrial production.
NONE is evident at the moment, indeed Friday’s data came in north of 3% growth:
That downturn may well come in Q1 2019, but it hasn’t happened yet, leaving room for another big rally.
What this correction has accomplished is dialing back GAAP P/Es in a major way:
Back to 2015 levels as much of the recent excess has been sucked out by this correction. In 2015 markets dropped on the heels of the earnings recession. The unprecedented liquidity infusions from central banks and the US tax cuts have resulted in a massive acceleration in GAAP earnings. These look to stall into 2019, but they haven’t turned south yet. Now that may well happen into next year, but hasn’t happened yet.
Indeed earnings are still expected to be strong into Q1 2019.
Bottomline, we still haven’t seen a massive slowdown, we have the anticipation of one, but it hasn’t happened yet and that creates an interesting conundrum for if a larger rally is to emerge investors may find themselves underinvested.
So however this week may begin how this week ultimately ends may be much more relevant. So far buyers keeping failing at the daily 5EMA and weekly 5EMA as resistance as they keep rejecting there and $ES closed below its weekly 100MA for the first time since 2016.
Yet sellers have failed to crack the .382 fib on $ES on a closing basis so far.
..while many indices remain heavily oversold and showing some signs of potential bottoming right at key support, the $DAX being an example here:
What will the Fed do this week? One rate hike and stop, putting their rate hike schedule on hold into 2019? Not raising rates and admitting the Fed made a policy error bringing its credibility further into question? Reducing the speed of QT?
Either way Jay Powell has a tough task this week. He’s the bag holder dealing with the fallout of what Ben and Janet bestowed on him, a market that can’t handle even a neutral rate. Pathetic. Bears have been right all along. The debt construct can’t handle normalized rates. We’re not even close to normalized and already the walls are closing in as the 6 risk factors hang like a sword of Damocles over the market.
And debt is expanding all around us virtually ensuring the next recession. Already in 2018 government debt has exploded by over $1.3 trillion, accelerated by tax cuts, and it’s getting much, much worse: U.S. government debt is rising at the fastest pace since 2012 and is projected to jump by $7.5 trillion from 2016 to 2023.
All this already built in before a recession hits and will make these numbers much worse crystalizing what I said earlier this year: This tax cut was the wrong plan at the wrong time and it will make everything that is to come worse.
Conclusion: Remaining on the cusp with price actioning worsening the Fed may again turn out to be the temporary saving trigger for a market that has been so dependent on it staying accommodative for 10 years. Let’s not forget the Jay Powell was still uttering the word “accommodative” during his most recent press conferences.
For this week: Sellers must force a weekly close below the .382 fib and February lows to fully trigger a topping pattern that points to 2341-2460 on $SPX, buyers need closes above the daily 5 EMA and the weekly 5 EMA. But not just a 1 or 2 day wonder rally will do. No Sir. Buyers need a face ripper rally to avert the break of the 2009 bull trend for now and move the debate into 2019. The technical parameters exist, but the bar is high.