Uptrends In Stocks Are Falling Apart

JC Parets
February 26, 2020

We've been very clear about how we wanted to avoid owning stocks this month. Fortunately, bonds have been the beneficiaries of the relentless selling in these stocks. Nothing has changed for the positive. But it's actually some former leaders completely falling apart that now has my attention.

Remember when Industrials broke out to new all-time highs? We said that as long as that was the case, how bad could things be? Well, Industrials are no longer above those former highs and actually just broke down to new 10-year relative lows. This is behavior consistent with an environment where we want to be selling stocks, not buying them:

Notice the bearish momentum divergence at recent highs now being confirmed with fresh oversold conditions. These are all characteristics of downtrends, not uptrends. So if $XLI is below $81 we can't own these names.

Remember that historically the Industrials, here represented by $XLI, have the highest correlation with the S&P500 of all the other S&P Sectors. Even higher than Technology and Financials. So I think we can all agree that this sector is really important, maybe THE most important. So Industrials completely falling apart doesn't make me anxious to go out and buy stocks. It suggests doing the opposite.

Look at the Dow Jones Transportation Average never breaking out to new highs like the Dow Jones Industrial Average has been able to do:

It's hard not to see how vulnerable Tranports are as they break to new lows on a relative basis and confirm bearish momentum divergences. If it sounds familiar, it should. All 20 stocks in the Dow Jones Transportation Average are in the S&P Industrials Sector.

If we're not above 11,100 for the Dow Tranports Index, we can't own these names.

Meanwhile, what do we know about Staples?

When stocks as a group are going higher, Staples underperform. When stocks as a group are going lower, Staples outperform.

Well, Staples are set up here for a real ripper relative to the S&P500. Again, would be consistent with falling stock prices, not rising ones:

Put Germany on the Mt. Rushmore of Global Indexes. We hold this one to a higher standard because it gives us a lot of insight into Europe. Well, like Industrials, this was a former leader that has now relinquished that title. In fact, it is now a poster child for why we're sellers of stocks as an asset class:

If the German DAX is below those late 2017 highs, there is NO reason to be long Europe. The risk here is lower, not higher.

So to answer the burning question of, "How low can we go?"

The short answer is I have no idea. We take the data as it comes in. For example, when we got all bulled up on stocks in early 2016, I thought it was just a trade. Later that summer we realized that it wasn't just a trade, but a larger stronger bull market. The data changed so we adjusted accordingly.

While we're still a hysterically small % away from all-time highs in most indexes and sectors, we can't call this a bigger storm yet. But I'm not saying we can't get there.

Here how I see it: 3000 in the S&P500 had been a big target of ours for a long time. When we broke out last Fall, that gave us a target around 3300. We not only got there, but slightly exceeded it.

Now that we have a correction, to revisit that 3000 level would be perfectly normal. That would represent exactly a 38.2% retracement of the entire 2019 rally. This level also comes right where resistance was in July and September. We know from our Polarity Principles that former resistance tends to turn into support. In other words, where there was an overwhelming amount of supply relative to demand, is now the opposite:

When you line up all these factors, 3000 for the S&P500 looks like a logical initial target. And, in the meantime, there is no reason to buy stocks if we're below these levels mentioned above in prior charts.

Well, what if it we break 3000? Then what?

In that case, things are probably getting significantly worse, pointing to, at minimum, a much longer amount of time for repair. At worse, it's pointing to a much more significant decline. 2750 would be that next level if 3000 can't hold.

That would mean about 11.5% decline peak to trough if we see 3000 and 19% peak to trough if we get down to 2750, just close enough to 20% where they won't label it a bear market. I never understood that.

Here is a longer-term chart of the S&P500. As you can see, these extension levels marked the top in 2015 and in this case, could potentially mark the bottom and retest of this next level. We often see these areas serving as resistance or support on the way up. This area wasn't quite resistance, but it can be support:

This is further evidence that 3000 level could prove to be important. Success or failure there will be information in and of itself.

So what's it going to take to turn this thing around? When are we buying stocks again?

Show me Financials finally breaking out to new all-time highs, and then we can talk. Seeing new all-time lows relative for Regional Banks doesn't make me feel warm and fuzzy inside. It reminds me of 2008. And in 2008 did we want to own stocks? No sir!

And in the spirit of banks and interest rates hitting new lows, I still think the chart of 10s is the one we need to watch. I can't think of anything more important on my radar right now.

If we're crashing to new lows in the US 10-yr yield, it's probably not because stocks are doing so well. We're already up to a 50% chance of 3 fed rate cuts this year. The trend here is down, not up. So unless we see some kind of miracle and rates hold 1.3%, things in stocks can get very volatile. We haven't seen anything yet.

Remember, in this sort of environment expect to see wide swings for stocks in both directions. That's normal for this type of market. The current implied volatility is pricing in an average daily move in the Dow of about 450 points. So just keep that mind. A VIX at 35 would mean we should expect 600 point daily moves.

Be careful out there.

JC

 

 

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