The Established Trend

Fear and fundamentals drive and power the market.  We know that news, whether financial or Geopolitical, does not drive or power markets.  That's not to say that news never affects the market, it is just that the effects are inconsistent and short-lived; good new is often poorly received by the market, while bad news is often embraced, and all reactions are temporary.  This reality makes using news to try and assign cause to market movements, or worse yet, predict the future course of the market, a total waste of effort.

History shows that bull markets climb 'walls-of-worry' while using a scaffold of healthy fundamentals.  At this point in the bull market, there is still a healthy amount of fear and an expanding business cycle.  This makes the October pull-back a normal correction within an on-going a secular bull market.

There is still a chance that the market could go down further, all the way to the 2400 area, without the bull market breaking down. 2400 corresponds to the long-term trend-line and the 50% Fibonacci retrace of the 2016-2018 rally (chart below).

However, we emphasize that the established trend continues to be bullish and, as long as there is fear and fundamentals supporting it, one should not bet against the established trend .

 

Equities

Sentiment

(Please see Thursday's AAII update)

The recent spike in bearish sentiment, supports the idea that the market has made a local bottom.  When there is this much fear in the market, it tends to support it.  This is not how bull markets end.

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The bear-to-bull asset allocation of the Rydex family of funds, has a strong inverse correlation with the SPX; a declining 36-week MA in the Rydex ratio is bullish for the SPX. Down-spikes in the ratio, correspond with tops in the market. In other Weekly Summaries, we have pointed out the similarity in trading patterns of the current bull market, with those of the tech bull market of 2000. During the later-stages of the tech rally, the Rydex ratio (nominal) made a down-spike early in 2000, but the 36-week MA continued to move lower while the SPX moved higher for another six-months before hitting its second (and final) high, and the Rydex ratio made its second (and final) down spike, after which, the 36-week MA started to rise as the S&P 500 corrected itself into a bear market.

What we wrote last week still holds:

Despite the fact that we have many reasons to think that this is not the start of a bear market, the behavior of the Rydex bear:bull asset allocation ratio is starting to worry us. Each time that the nominal ratio value made a double down-spike and the 36-week MA started rising, the SPX corrected into either a bear market (2000), or into a significant local correction (2011 and 2015). That is the situation we are in now; the nominal ratio has formed a double down-spike, and the 36-month MA is starting to rise.

In 2011, the market corrected -19%, in 2015 it went down -14%, and as of this past Friday, the market is down almost -10%. The market could end up correcting down to meet the long-term trend-line in the 2400-2450 area which would result in a -17% correction. The bull market would not necessarily be over at that point (just like it wasn't over in 2011 or 2015), but it would be a painful correction.

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The VIX has started to back off after making a lower-high.  This, also provides confidence in the bounce.

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Technical

The emerging markets (MSCI) started diverging from the US market earlier this year.  The chart below shows that after every down-spike in the correlation, with the exception of 2002, there is a rally in the SPX as the correlation returns to the more usual positive (red, dashed vertical-lines).

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The C4 correction pattern from 2000 continues to replicate today.  One notable difference between these two time periods is the lower bullish sentiment present today.  This difference could mean that, in the bigger picture, the present bull market is much younger and has further to go at this point than the euphoric market in 2000. 

We will start to unload our recent long positions as the market approaches the 50% retrace level and 200-day MA (~2760).

 

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Fundamental

 

The PE pattern of the C4 correction in 2000 continues to replicate in today's market; it increased during the R4 rally and decreased during the C4 correction (black dashed-arrows in the two graphs below).

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Gold

 

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The gold miners have been turned back from resistance, even as the gold price has held up. The HUI Gold Bugs index has, once again, closed below resistance at 150, and the RSI remains below its upper trend-line. This weakness predicts future pressure on the gold price.

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The commitments of gold futures traders have slightly increased to already historically extended levels.  We continue to view this indicator as neutral.

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We wish our subscribers a profitable week ahead.