In this continuing series, we've analyzed the fundamental drivers for the bullish run in equities and financials. In this analysis, we'll look to the charts to see how those fundamentals might impact price action for the S&P 500.
The fundamentals driving equity markets:
The discussion over whether Trump policies will come to fruition have heated up lately, following the failure of the House of Representatives to pass healthcare reform.
Here's what Mr. Rubenstein of The Carlyle Group, a private equity firm with over $58B in equity capital under management, had to say on Trump tax cuts:
"The President will no doubt have some principles that he'll set forth soon and no doubt there'll be corporate tax cuts in those and repatriating money from offshore. I think that'll probably happen in the next week or two or three… but I think it'll take about a year before it gets done," said Rubenstein" - CNBC
Any change in the fundamentals outlined above will have a lasting impact on equity investors who are long the S&P via the SPDR S&P500 Trust ETF (NYSEARCA:SPY), those long banks via the S&P Bank ETF (NYSEARCA:KBE) and the Financial SPDR ETF (NYSEARCA:XLF) and Treasury investors via the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT).
Analyzing the charts to see how the fundamentals might drive S&P breakouts and pullbacks:
Channel lines and how they relate to the fundamentals.
As the market moves up and down, the volatility can be dizzying. Drawing channel lines can help us visualize the trend amid market volatility. Channel lines simply connect the key levels of lows and highs in the market, thus creating a visual representation of the direction of the trend.
It's this author's opinion these lines (often referred to as technicals) do not drive the market higher or lower. The economic and company fundamentals drive price action not the charts. However, investors use these channel lines to place buy and sell orders, and when these orders are triggered, the market can move rather violently. But it's worth mentioning again; the fundamentals have to move first for these orders to get triggered and for the move to have lasting power.
A look at the S&P pullback:
Until the S&P breaks below the yellow lines, the market remains in a bullish trend.
In managing portfolio risk, watch for volatility to spike as the S&P approaches and especially if it breaks below one of the higher lows. The areas highlighted in yellow will likely have sell orders to unwind long positions, and the triggering of those stops would exacerbate any downward move.
We can debate the merits and failings of technical analysis. And whether we utilize the analysis for our individual trading style or not, many investors including hedge fund managers use these key levels to place their sell orders (i.e. take-profit orders). Of course, the fundamentals drive the technicals and price action on the charts, but the enormous amount of capital flows from hedge funds are a significant driver of market direction as well.
How the last range-break, driven by fundamentals, pushed the S&P 9% higher:
The S&P retraced and consolidated from May to November last year. And following the Trump election, the market spiked out of the 9% range (consolidation) it was mired in, as shown by the yellow rectangle.
Following a range-break, the market can sometimes (not always) go the length of the range or in the case of the S&P, 9% to 2400.
Why the S&P is currently in a 16% move higher, and 2450 is a key area, likely to contain sell orders and market resistance:
If the S&P breaks lower:
In the short-term, if the S&P breaks 2320, a test of 2250 is possible. However, look for any fundamentals factors in the market to determine if the downward move has lasting momentum.
Final Note on risk:
For long-term investors, these selloffs may not be an issue since they have time to wait for the market to rebound.
However, for retirees who live off their investment savings, who may not be able to handle a 10-20% correction in the market, employing risk management strategies around these sell zones is prudent.
More to follow on equities, financials, the dollar, and yields in the coming days and weeks.
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This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.