Stock Market Chartology

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by: Ivan Martchev

In my experience, purely technical traders don't care for the fundamentals, and vice versa: Fundamental analysts don't follow the technician's playbook. Still, I have not met a single futures trader who does not know how to read a chart - and futures trading is a big business.

While I don't dismiss charts out of hand, I need to know what is going on behind those charts - the fundamentals, if you will - to see how they play out on that chart. With that in mind, what is this chart of the popular S&P 500 Index saying?

SPDR Standard and Poor

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This is what an uptrend looks like - where the upward zigs are bigger than the downward zags, creating a series of higher highs and higher lows. Also, the popular 50- and 200-day moving averages are rising smoothly. They say that bulls live above the 200-day moving average and bears live below it. To qualify this trading maxim further, bears like to see a declining 200-day moving average, which clearly we do not have at the moment. It takes several intermediate-term sell-offs to turn a 200-day moving average lower.

In that context, we saw some interesting trading action on Friday. The SPDR S&P 500 ETF (NYSEARCA:SPY), which trades off the S&P 500 futures market and not the cash market, performed a rather interesting trading pattern called "an outside-down" day. You can see last Friday's action in the final red bar on the chart above, which shows that the market opened up, made an all-time high ($245 on the SPY), and then saw an influx of sell orders that caused it to trade below Thursday's lows and close below those lows.

An outside-down day is a short- or intermediate-term reversal pattern, suggesting that we may see a short- or intermediate-term correction. It certainly does not mean that "the world will end" in the bearish sense of the term. It is impossible to say at this point if this all-time high registered on Friday will be an all-time high that will stick for some time, or will be taken out after we complete this correction. All corrections in the past year ended in the vicinity of the 50- or 200-day moving average, which is a sign of a strong trend.

Fundamentally speaking, I see trouble brewing in the White House. Without sensible tax reform and an infrastructure program, I think that the chances of seeing a recession before President Trump is out of office in 2021 are close to 100%. This prediction is not a political statement but a statistical one. In the 240-year history of the United States there has never been an economic expansion longer than 10 years. Since we just completed Year 8 of the present economic expansion, I have a great deal of trouble figuring out how Mr. Trump will boost economic growth with a former FBI director (Robert Mueller) as a special counsel with all the resources of the FBI available, breathing down his neck. This has to be one of the all-time great presidential distractions. We are all innocent until proven guilty, but it sure fuels high ratings in the masterful first season of Trump's new reality hit show, which I will dub The Presidential Apprentice.

Some Background on the Last Three Stock Market Crashes

Having a recession does not mean a repeat of 2008. I do not see the financial system in the kind of trouble we saw with the implosion of the mortgage market right at the time of the all-time high in October 2007, coupled with an inverted yield curve (for more, see my June 6, 2017 MarketWatch article, "The bond market is giving the stock market a stern warning"). While we don't have an inverted yield curve yet we have a flattening yield curve, which means the bond market is predicting a slower economy, most likely in 2018. This also means the bond market no longer believes the President's bombastic election promises.

Dow Jones Industrial Average from 2000 - 2010 Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The 2002 bear market (above) seemed severe, until we experienced 2008. The reason why a 2008-type decline is not probable now, even though the possibility can never be ruled out with 100% certainty, is that we need to have more than a recession for a stock market crash. Crashes of such magnitude have happened for very specific reasons three times in the last 100 years, specifically, 1929, 1974, and 2008.

Dow Jones Industrial Average from 1926 - 1936 Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In my opinion, the 1929-32 crash (above) is most similar to 2008 as both were credit-bubble driven. The difference is that in 1929 the Federal Reserve was clueless and added fuel to the fire by exacerbating the popping of the credit bubble with tightening of monetary policy at precisely the wrong time.

The other moronic maneuver was the Smoot-Hawley Tariff Act that was signed into law on June 17, 1930. Ultimately, the economic disaster catalyzed by the Smoot-Hawley Tariff Act helped FDR and the Democrats come into power and, in effect, repeal it with the Reciprocal Trade Agreements Act of 1934.

While it can successfully be argued that the Federal Reserve has learned from their Great Depression mistakes, this has yet to be determined when it comes to the present day political establishment.

Dow Jones Industrial Average versus Crude Oil Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The 1974 crash had to do with the oil price shock from the oil embargo and the Middle Eastern mayhem. While the Mideast mayhem part is still alive and well, we don't have an oil embargo. In fact, the oil price is rather weak in what should be a seasonally strong period of the year. I am thinking that the start of a long-overdue economic downturn in China may be one reason for the drop in the price of oil this year.

Crude Oil Price Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The economic situation in the U.S. does not yet indicate a bear market ahead in stocks, but we are overdue for a correction. I think the global economic risk is centered on China first and Europe second, which raises interesting questions about the broken-down correlation of the MSCI Emerging Markets Index that has deviated from its long-standing correlation to the price of crude oil. It is my experience that those two can deviate sometimes but that correlation tends inevitably to reassert itself. If I were given the choice today to pick between the S&P 500 and the MSCI Emerging Markets Index, I would pick the S&P.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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