Rougher Waters Ahead

Navigator Algorithms - 100% Cash

Looking at January, not to mention last week, what we can say is that the market rejected further gains above December’s high. Of course, this also means that we are coming back into the megaphone channel and dropping below the weekly wedge pattern.

From a weekly perspective, the market rejected four weeks of gains last week, ending January essentially flat. This leaves the broad market flat for the year.

As the saying goes, “so goes January so goes the year.” It is a nice saying but unsupported by actual statistics. Nevertheless, the market sorely needed to digest recent gains and work off the froth. GameStop risk (with counterparties behind the curtain) triggered the sell-off and reminded investors just how leveraged this market is (with record call options) and how it might behave when you roll the tape backward.

Does that mean this is THE top or a major top? Of course, I don’t know but reverse “V” tops are rare. Topping is a longer process, at least in the absence of an exogenous event. For now, I am viewing this as a first down leg, which may turn out to be part of the topping process for a deeper intermediate correction that ends mid-February. Outperformance by defensive sectors last week underscores that opinion.

But as I have stated, a major market top would more likely present towards the end of spring based on the predominant, 18-month cycle. Between now and then, the topping process could involve a lot of lateral action, meaning the January high would not be exceeded. We are in cash for now, and we will remain on bottom watch, culling through our lists.

On a positive note, the Navigator core model was up 55% for the month. We were stopped out of my brief foray into the XLE Friday, though oil held its ground firmly. Unfortunately, the XLE got caught up in indiscriminate selling associated with the GameStop hedge fund fiasco. The hedge funds, along with some banks, clearing firms, and other counterparties, were forced to sell other securities to maintain short positions and cover margin calls. With Robinhood further limiting sales of up to 50 securities, market participants got spooked and fled to cash.

My initial target of 3650 on the S&P 500 futures has been tagged tonight, and the market bounced. At this writing, the S&P 500 futures have reclaimed 3700. That is a net positive, as are the fear gauges showing that a short-term bottom should be close at hand. At least some of the froth is off the markets for now. Further gains will depend on what the Europeans do later tonight. At least the Asians are buying.

Notably, the Weekly Expected Move based on Friday options expiration has nearly double from last week, with the low end of the range at 3600 and the high end near 3900. Clearly, market makers are expecting considerable volatility this week, given a 300 point range.

I would expect the market to bounce here, then fail about halfway back before moving down into the next nominal 40-week cycle correction slated to trough around February 15th. We should zig and zag a bit until we finish. As pointed out in the 2021 outlook video, 3500 is looking to be the worst case for now – and we would be lucky to tag it for a nice, bottom entry point. I always keep an open mind about all possibilities and will continue to trade what is in front of us, regardless of forecast and opinions.

Given the systematic risk associated with the GameStop phenomenon and the high correlation right now among all S&P 500 sectors, I don’t expect energy stocks to counter the market forces, even though oil is performing well. So we will use a more generalized market bottom to reenter this important sector and inflation hedge.

Next week is the impeachment trial, and rancor dominates Washington, D.C. The Reddit crowd is now setting their sites on silver. So the road ahead will be rocky for a while, and the markets are likely to reflect the same.

As always, stay tuned.

A.F. Thornton