Over the past two weeks, the Federal Reserve and the ECB have begun to mount one of the most audacious jailbreaks in the history of financial markets.
I'll explore some thoughts on the economics, politics and potential pitfalls of it all in a separate post, but in this modest update I want to take a look at what's likely to be the short and medium term impact on the stock market.
Let's begin with a swift video rundown of my most reliable technical indicators, come to a view, then examine that outlook in the context of the bigger picture.
So how does this outlook, for a modest correction within a continued bull market, fit into the bigger picture?
ROCKET BOOSTERS
AT THE EDGE OF SPACE
AT THE EDGE OF SPACE
Before the ECB announced its cunning bond-buying plan on September 6th, US markets had been approaching a major technical barrier.
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| Source: http://www.marketanthropology.com |
In his thought-provoking Market Anthropology blog, Erik Swarts has been drawing attention to this quarter-century-long trendline connecting many of the most significant tops and bottoms in the S&P500 since the great bull market began. Investors' numerous attempts to breach this from below have been successful just once - at the start of the tech and credit booms in 1995.
Here is a close-up of the current battlelines...
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| Source: http://www.marketanthropology.com |
The 'meridian' line was acutely respected in 2011 when the market cratered almost 20%, and a smaller reaction occured as it made another attempt this spring. The current rally has a date with the barrier once again at the September 'meridian' of $SPX 1486.
With a potentially unlimited supply of Fed liquidity now pushing financial institutions into the accumulation of risk assets, we must recognize that the fuel does potentially exist for such a breakout to occur.
With perfect timing, the Fed has ignited its monetary rocket boosters in an attempt to overcome the force of financial gravity. The question is whether the downward pull of a deccelerating and deleveraging global economy will prove powerful enough to overwhelm that effect.
The exact same breakout area is also identified by this extraordinary channel which is constructed using Dow Industrials prices stretching right back to the Great Depression:
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Source: Kimble Charting Solutions http://advisorperspectives.com/dshort/guest/Chris-Kimble-120814-Dow-Update.php Please open in a new tab or window to enlarge |
Price is now attempting to breach a mighty channel boundary connecting many major highs and lows back to 1937. It succeeded in doing so once previously, as a head of steam built up in the mid- 1990s boom.
Even if one were to discount this kind of technical approach, the Dow and S&P500 are also now within striking distance of all-time highs. A break above those levels would open up the possibility that the secular bear market, which has gripped stocks since 2000, is finally over.
It would seem therefore that, from a long-term structural perspective, the stock market has reached an absolutely critical point.
THE DOME OF DOOM...
MAY HAVE AN ESCAPE HATCH
This belief that we are at an inflection point has been reinforced by two reliable price patterns which suggest the bull market is nearing its end.
First, the notorious 'Three Peaks & a Domed House' sequence I've been following in these pages has progressed exactly as expected and recently moved into the final phase of its ascent. It now needs to confirm with a sequence of lower highs and lows from an approaching peak at 'point 23'. Having looked at all the technical evidence (see video) and discounted the possibility that we are at a top right here, I see only one way this pattern could realistically play out. Fortunately, it does coincide with my view of a shorter-term correction within a continuing bull market.
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THREE PEAKS AND A DOMED HOUSE Post-Fed, it's looking like a case of 'close but no Cigar', but there's one way the pattern could still play out |
There's no doubt that the ECB & Fed bazookas have shifted the odds against the Three Peaks pattern playing out as anticipated. It seems almost unfair that, after nearly two years of gestation, it may now fail to deliver its spectacular bearish denoument. But the truth is that there is no Three Peaks pattern until it confirms by making a trend reversal at the Dome and there's nothing which makes that inevitable.
As with any chart reversal pattern, you take your life in your hands if you jump the gun and trade assuming it will trigger in the direction you anticipate. Assume wrong and you can suddenly find yourself driving the wrong way down a six-lane highway. The NYSE's halls echo nightly with the ghosts of traders crying: "If only I'd waited for the breakout..!"
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| The 'Three Peaks' pattern that never was... |
STICK A FORK IN IT -
BUT DON'T EAT IT WHOLE
Another technical indicator which has been an outstanding guide during the bull market is Andrews' Pitchfork. Positioned on a chart of the Dow since the 2009 low, this deceptively simple geometric tool has been able to show, in advance and with great accuracy, where the major turning points would come and where important support and resistance to prices should be expected.
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Andrews' Pitchfork, Dow Industrials, 2009 - |
Bull markets tend to die a slow momentum death, and this is one of the tools which can help us identify the stages in that process.
Having failed to reach the upper boundary early in 2012 then broken below the median line this spring, the re-invigorated Dow is now attempting to push back above that line in a fresh surge of momentum. With Fed winds at its back it may succeed, but what is more likely is that any strength will see it edge higher along the path of the median. Progress would be a slow, choppy affair, until a long-lasting break higher or lower is ultimately determined by the greater forces at work.
CONCLUSION:
FIGHTING GRAVITY
FIGHTING GRAVITY
The Fed and ECB are engaged in a life-or-death battle with the forces of economic gravity. A mountain of financial and household debt is being destroyed (or more accurately, dug up, sod by laborious sod). We remain in a depression which, if left to run its course, would have destroyed the financial system in 2008 and looks ready to return with a vengeance if not kept heavily contained. The recent global slowdown, now gathering pace in China, deepening in Europe and fitfully infecting the US, will either be countered globally by policy-makers, allowing confidence to return to markets for a period, or errors will be made in managing the crisis and the depression will take its course in a disorderly manner. Such an outcome would provoke a collapse in the price of risk assets.
Expressed in terms of the technical picture and the two price patterns above:
- Three Peaks: either the current sequence of higher highs and lows in $SPX is maintained and the Three Peaks pattern is invalidated... or a shallow correction will lead to an exuberant high later this year or early next, following which new highs are not made and a stealthy and perhaps lengthy reversal takes shape
- Andrews' Pitchfork: either prices push back above the median line, using it as support for a major surge higher or, after a sideways correction and another failed attempt to breach the median, price begins to break down in volatile fashion.
As things stand, indiscriminate buyers are straining to get in, certain that the Fed has their backs covered. So it may
ultimately prove more profitable, and less stressful, to step in gradually on sharp dips in anticipation of at least one more enthusiastic push higher later in the year, than to short now in hope of a correction which may turn out to be frustratingly choppy, side-long, and shallow.
