Are We Out Of The Woods Yet?

It’s been 40 trading days since the big, December 24th low when the market completed its short-term correction bottom, falling a total of -19.8% from the Sept 21st high. Since then, we’ve seen an impressive rally take place, but there are a lot of questions that need answered at this juncture. What does the market need to do in order to continue its velocity and trajectory? What is the market telling us in terms of its current long-term trend? Is the current weight-of-the-evidence leaning positively or negatively? Let’s take a look…

It’s been an interesting 12-months for the stock market. We’ve now seen pullbacks and corrections of -10%, -8%, and -20%, all in merely a year! Most recently, the market has experienced an impressive bounce off the most recent correction lows, leading many to wonder “Have we seen the bottom in stocks?” Questions like these can cause some investors to experience FOMO (Fear Of Missing Out).

Paying too much attention to the month-to-month fluctuations in the markets can cause the investor to change their time-frame from long-term to short-term in a matter of weeks! The key point I want to make is that we need to always keep our eyes on the horizon, not our feet. Remember driver’s education? “Aim high” they said… Don’t stare at the road right in front of you!

As mentioned last week, the S&P500 cleared its 200-day moving average (rose shaded area) and was able to close above it for three days (just barely). Now that the market has spent just over a week in more positive, bullish territory, here’s what I’m paying attention to:

1. Can it stay above the 200-day moving average?
2. Will it have enough strength to push higher, above the red-dashed line below, which marks a potential ceiling of resistance from the Oct/Nov highs?
3. Will we see stronger volume if it rises (and weaker volume if it falls)?
4. And can momentum manage to find its way above (the key level of) 70 in the lower pane, below?

What do I like about the market right now?  The positive evidence I see is simple… the market has managed to close above its 200-day moving average, indicated by the rose-shaded area, above.  That’s a big positive.  I also like how small-cap stocks have been outperforming the larger-cap S&P500 index.

As you can see in the chart below, whenever the chart is rising, small-caps are out-performing.  Whenever it’s falling, small-caps are under-performing.  The reason out-performance of small companies is good is because it indicates risk appetite.  In other words, if investors are willing to take more risk and put more money into smaller, “riskier” stocks, then they must have confidence that the market as a whole could rise further.

However, as you can see in the same chart (above), the outperformance of small-caps to the S&P500 is also running into some potential overhead resistance, just like the market itself in the first chart I shared.  If this relationship between “riskier” small companies and “safer” large companies begins to wane again, sending those riskier assets southward, this would not be a good sign for the market and thus, this piece of evidence would be thrown out the window.

So, while we’ve seen some positive short-term changes in the market, I don’t believe we’re not out of the woods yet.  We deployed some cash last week into some small positions in commodities and stocks, but while I’m optimistic, I’m still cautiously so.

It doesn’t matter what we “think” the market will do.  The market will do whatever it wants, and it always manages to disappoint all those who hold a strong opinion one way or the other.  This next week is going to be interesting, and the next few weeks will be crucial in terms of whether or not stocks can remain in a flat, trend-less state, reversing upward… or if the long-term downtrend will continue.

Remember, lower-highs and lower-lows are not healthy – and more than anything, patience and an open mind are instrumental during transitionary times such as these.

Till next time…

Adam

Categories: Adam Koos, CFP®, CMT®, Market Commentary

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