Wednesday, February 8, 2017

Why The End Of The Post-Election Rally Might Finally Be At Hand

The risks are piling up, so I’m watching for a loss of momentum in stock prices.


By Thomas H. Kee Jr.
MarketWatch
February 8, 2017

This is how I’m viewing the U.S. stock market:

• No one else cares about the inherent risks in the stock market today, so why should I?

• The price-to-earnings (P/E) multiple on the S&P 500 Index SPX, +0.02% is almost 26, much higher than the historic average of about 14.5. But no one else seems to care, so why should I?

• The stock market indices are pressing all-time highs, and they have not had a drawdown of any material magnitude since the election, which suggests a sustained decline could come at any time. But no one else cares, so why should I?

Which brings me to a truism: The market never cares until it has to care.

History has told us that the market does not care about risks during momentum moves like the ones we’ve had since the election. But when that momentum begins to lose steam, the market, which once saw no risk, can suddenly perceive massive amounts of risk without any real change to the environment.

The timing of such a transition in sentiment is difficult to pinpoint in advance, but there are tools at our disposal: technical, longer-term trading patterns and, specifically, the resistance levels in the Dow Jones industrial Average DJIA, +0.19%the S&P 500, Nasdaq 100 NDX, +0.35% and Russell 2000 RUT, -0.41% By watching those resistance levels, we can have a rough idea of when price adjustments might take place.

Ultimately, price adjustments are part of the process in which sentiment shifts.

As a result, the identification of these longer-term resistance levels is critical to understanding when momentum-driven increases will come to an end, and I offer, below, the longer-term chart pattern of the Dow that I provided to clients.

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In the chart, you can see that longer-term resistance levels have been tested, and you can also see a long-legged Doji formation from last week’s trading activity. (A Doji formation signifies indecision between bulls and bears.) This combination sets up a potentially bearish, or higher-risk, environment that would be confirmed if the market drops from these early-week higher levels.

Downside confirmations do not immediately exist; we have only tests of longer-term resistance levels right now. But if downside confirmation comes, it will likely be a signal that the one-sided market moves will come to an end, if only for a short while.

We are monitoring for downside confirmation, but we have already acknowledged that the risks now are extremely high, much higher than they have been, and the end of the momentum that spurred the Dow higher by 12.3% since early November may be in sight and, with that, a healthy drawdown.


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