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Stock Market: What Melts Up Must Melt Down, Right?

Stock Market: What Melts Up Must Melt Down, Right?
Climbing The Wall Of Worry

The market (NYSEARCA:SPY) has been steadily melting up since hitting its bottom in March and there are a number of reasons to believe that trend will continue. Among them are a rapidly improving economic and earnings outlook that are both fueled by the post-pandemic reopening. Regarding the data, there is evidence within the labor, retail sales, and housing figures the rebound is already stronger than anticipated, and that only means good things for future earnings.

That said, Wednesday’s 2.6% pullback in equity prices may the beginning of another major sell-off. Despite the outlook, the market is still afraid, and for good reason. The COVID-19 pandemic isn’t over and the economic recovery is on tenuous footing. The question now is, is the market still building a Wall of Worry from these bricks of news or is the load getting too heavy to bear?

What’s Weighing The Market Down?

The Pandemic - The pandemic is the #1 item weighing on the market today. The reopening is not going as well as hoped, there are hot-spots and record-setting outbreaks in key U.S. states that point to a second round of shutdowns. Apple is perhaps the most visible having already re-shuttered nearly 20 stores in hard-hit areas. Disney is another second-guessing its plans to reopen; if it does the outlook for this year’s revenue and EPS is out the window.

On Wednesday, the IMF downgraded its projections for 2020 GDP growth to -4.9%. That was another reality check for markets moving higher on mostly-hope. If the reason for hope is taken away from the market you can be sure a melt-down will soon follow.

The 2020 Election Cycle - Do not doubt the 2020 Presidential Election Cycle as a major mover of the market. The latest polls show Joe Biden with a commanding lead over incumbent Trump and that does not bode well for business. The #1 and #2 fears are that Democrats, if given control of the House and/or Senate along with the Presidency, will roll back Trump’s tax cuts and begin another wave of crippling regulation. That’s not good for profits, not at all, rolling back the tax cuts alone could be worth as much as 10% to 20% of current EPS projections.

Now, I’m sure some of you out there are thinking something like “but the polls were wrong in 2016, I don’t trust them”. What you need to understand is the polls were spot on (within the margin of error) when it comes to the popular vote. I have no doubt that Joe Biden will win the popular vote with NYC and Los Angeles County behind him. It’s the electoral vote that counts though and we won’t know those results until they come in.

The Technical Picture; Where The Rubber Meets The Road

The technical picture is bullish with a caveat; the long-term monthly and weekly charts are very bullish but the shorter-term daily chart is very iffy. What this means to me is one of two things, either the market is setting up for another leg or its in reversal. That’s the rub with technical analysis, the signals are similar until confirmed. The move(s) we’re looking for here is either a confirmation of support, renewed buying, or a confirmation of reversal, intensified selling.

What Melts Up Must Melt Down, Right? In the first case, a confirmation of support, potentially at the 3,000 level, would lead me to believe the market is in consolidation and not reversal. A consolidation, possibly a bullish triangle, would be very telling and most likely lead to a continuation of the melt-up rebound.

Assuming the accepted technical rules of price projection are still intact the end target for such a move would be near the 4,000/4,200 range. But it depends on the data and the reopening. In the second case, a confirmation of reversal may come in the form of a drop below the 3,000 level.

The caveat here is that such a move may not necessarily indicate a reversal, I’d have to wait and see how the candles developed to be sure. But, assuming a reversal/melt-down is in store the targets for support become 2,800, 2,600, 2,400, and 2,200 (the March low).

The good news is the long-term secular trends that drove the market to its pre-pandemic high are still intact. And there is no reason to think they won’t persist long into the future, at least not right now. With that in mind, a move lower, perhaps as deep as the March lows, will be a buying opportunity of generational magnitude so be sure to have your cash ready.

Until then, stay focused on high-quality, blue-chip dividend payers insulated and/or boosted by the pandemic.

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Thomas Hughes
About The Author

Thomas Hughes

Contributing Author

Technical and Fundamental Analysis

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