This is a Guest Post by AK of Fallible
AK has been an analyst at long/short equity investment firms, global macro funds, and corporate economics departments. He co-founded Macro Ops and is the host of Fallible.
Is The 2019 Stock Market Crash Over? | Why The Bear Market Will Continue
Is this latest down move finally over? Or are we just setting up to fall again? Find out in this video…
The S&P 500 is trading higher off a short-term bottom. We should see it run up into the 2,600+ range — its 50-day MA acting as an attractor (red line) — but as I note on the chart below, the market is going to bump into significant resistance here. There are a lot of players who bought into this range that are underwater and who will look to close out their positions for breakeven once price climbs back to these levels. This is called a supply overhang.
With large supply overhangs like this, it typically takes the market a number of attempts before it can break through and move to new highs. The supply needs to be worked off and so I’d expect to see a reversal around the 2,650-75 range followed by a selloff to recent or even new lows — double bottoms are typically the pattern we see after large selloffs like these.
Druckenmiller often talks about how “the market is smarter than he is and so he listens to the signals of the market” to figure which side of the trade to be on. One of the things he pays close attention to — and we at MO do as well — is the trend in cyclical versus defensive stocks.
Check out the chart below which shows cyclical versus defensive stocks (orange line) and the S&P in blue. When the orange line is trending up, it means that cyclical stocks are outperforming defensive sectors. This means that investors are moving to more risk-on positioning as their perceptions of future economic growth become more optimistic. And when the orange line trends lower it means that investors are becoming more defensive in their positioning and more pessimistic on the market outlook.
Now we want to see the trend in cyclical vs. defensive confirm that of the broader market. When it doesn’t, it often means that the market’s internals are shifting and there’s likely a major change in trend coming, as we can see in this chart.
We want to see this orange line (cyclical vs defensive) put in a higher low in order to signal a shift in market internals and confirm that a bottom is in.
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***All content, opinions, and commentary by Fallible is intended for general information and educational purposes only, NOT INVESTMENT ADVICE.