Whether we like it or not, if we participate in markets, we’re in the risk management business. If we don’t have a plan for when we’re wrong, it’s a problem. And if we don’t think it’s possible to be wrong, it’s an even bigger problem. The market is about possibilities, not guarantees. Markets owe us absolutely nothing and are brutally efficient at making us pay for poor decisions. As you know, we like to look for evidence to support our investment decisions. The best piece of evidence is price. What is it doing? What’s its direction? If price is making higher highs and higher lows, the trend is up. If price is making lower highs and lower lows, the trend is down. By analyzing price itself, we can determine the general trend and the potential change thereof. How do we do this in reality? Simple. Just look left. When we analyze price using charts, we find the current price and look left. See the daily price chart of the S&P 500 below. Notice that price has been steadily making higher highs and higher lows. It is a beautiful staircase upwards, hallmarking an uptrending market. That is, until March 21st.
On March 21st, many U.S. markets, including the S&P500, broke down from consolidation. Keep in mind, consolidations typically resolve in the direction of the primary trend. In this case, an upward resolution would have indicated a healthy market and an ongoing uptrend. When consolidations resolve in the opposite direction of the primary trend, we need to respect the weakness (aka supply) hitting the market. If there’s not enough demand to keep the S&P 500 ($SPX) above 2363, it’s significant. Not only did selling pressure push price below 2363, it also caused a break of the momentum trendline (in green) that’s been in place since early December 2016. Consequently, a lower high and lower low have been locked in. Lower highs and lower lows are the very definition of a downtrend.
What now? Buying urgency needs to pick up immediately to reclaim 2363 and reenter the sideways range established since the beginning of March. If buyers can’t accomplish this in short order, there is a very strong possibility for price discovery to take the S&P 500 down to an area of prior demand near 2277. A visit to the window of 2240-2277 would be a logical retest to see if buyers are serious there. It would equate to a 38.2-50% retracement (for you Fibonacci aficionados out there) of the rally since the November 6, 2016, low. More important, we need to understand this would equate to a correction within a bigger picture uptrend in place since mid-2016. A -5-6% correction from the March 1st high would be extremely normal behavior for a market that just broke out of a 2.5-year consolidation back in July, 2016. Any pullback here should be viewed as an opportunity to buy back into a strong bull market. If and when we visit 2277, we’ll revisit this information and see if there is additional evidence to consider.
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