View from the Top Down - 7/19/2021 | Archimedes Methodologies

In this Weekly Series, We Examine the Market From a Big Picture, Swing Trading Perspective. We Use the S&P 500 Index as our Broad Market Proxy, and All References to the Market Refer to the S&P 500 Index Unless Otherwise Noted. The Market Remains the Most Significant Variable in Higher or Lower Stock Prices, Influencing 60% to 70% of Individual Stock Price Movement. The Decision to Be Long or Short Based on the General Market’s Direction is One of the Most Important Decisions Investors Will Undertake.

Bottom Line

We tripped the stop on our 10% position in the XLF (Financials ETF) Friday (6/16), and this was preceded by several Navigator sell signals in the S&P 500 index Thursday (6/15). The XLF was our only swing position, so we are back to 100% cash, but the key question this morning is whether the bulls, once again, will buy the several-day pullback or whether the long-expected, intermediate correction has finally worked its way into the S&P 500 and NASDAQ 100 indexes.

Arguably, there has already been a stealth correction well underway in many economically sensitive sectors since April – but masked in the indexes by the weighting of a narrow group of large-cap growth stocks. Another rotation from tech and growth back to value and cyclicals could keep the rally alive or at least put the market into a trading range for the foreseeable future. However, we would need to find the bottom of that range in this pullback.

Sentiment indicators are already showing considerable short-term fear, so I would expect a fairly quick resolution of this first down leg. Unfortunately, that does not tell us where the price will pivot or where we go from there. Watching the Morning Outlook for Day Traders will help you identify the key levels for a turn.

Technical Discussion

Coming from the top of the short-term trading channel on Tuesday (7/13), by Thursday (7/15), the market had closed below the previous day’s close (at minimum a “heads-up” alert). This also generated a preliminary (yellow) Navigator Swing Sell Signal, with further confirmation from a close below the Navigator Algo sell trigger. However, the 5-day line held, if just barely.

By Friday (7/16), the market closed below the 5-day line, with the weekly bar closing below the prior week’s low for the first time in five weeks (another important “heads-up”). All of this occurred on multiple breadth, momentum, and strength divergences failing to confirm the recent index highs at the channel top, which consummated a selling climax and throw-over at the top of the channel. Our sole position, a 10% position in the XLF, closed below its 5-day line Friday, triggering our stop. This resulted in a small loss and put us back to a 100% cash position in the Navigator swing strategy.

The price action this past week underscored some key takeaways from last week’s View from the Top report. I had pointed out the negative breadth (and other divergences) in a market (using the S&P 500 index as our proxy) that was long overdue for an intermediate correction. The 18-month cycle top still loomed large. At best, though, the cycle bottom has such a time variation that the potential cycle topping zone can only provide some context to what we can currently observe in real time on our screens.

In fact, I believe that the cycle has been operating stealthily in many sectors since April and may finally be catching up to the major indexes. One expectation I communicated was the unlikelihood of July closing as another positive month, given the statistical probabilities. Naturally, that supposition would need to manifest soon, as we are 2/3 of the way through the month.

Also, I have been pointing out the Butterfly harmonic sell pattern in the NASDAQ 100 over the past few weeks. As the NASDAQ has been the recent market leader, its breakdown from the pattern would be a negative development for the broad market.

Finally, I pointed out the rally in defense/risk-off sectors and asset classes, such as treasuries, as eerily similar to signals I observed in January 2020, right before the China Virus crash. While not predicting a crash, I pointed out that the rally in stocks and treasuries basically was a contest. Only one of these asset classes could be right in the current circumstances.

Nevertheless, I also pointed out that the relentless bulls would continue to buy one to three-day pullbacks until such buys stopped working. This morning, we will get a chance to test the bulls, as the market is trading such a pullback right to the 21-day line. The 21-day line typically divides the short-term up or downtrend. It also provides support for the market more often than it doesn’t. After that, more support congregates around the 50-day line.

If you backtrack several months, you also will see that most of our pullbacks this year have been right at this same mid-month period into monthly options expiration and only lasted a few days. Friday was monthly options expiration, in addition to weekly.

Recall that the June pullback on quadruple expiration Friday left a scary bear bar closing at its low and below the 50-day line, only to see the bear breakdown fail the following Monday. The market followed through and continued the next bull leg up through last week. The bulls will be similarly tested once again today.

Also supporting the bulls, the CNN Fear Greed Index (above) is down to 23, and the CBOE total put/call ratio (below) spiked again on Friday. So sentiment would support a short-term low and turnaround here, though there is no indication whether the 21-day line will be good enough for a pivot point or whether we will need another trip to the 50-day line or some other level.

And even if the market turns quickly again, there is no assurance that the trend will resume. Recall my prediction in the last writing that a trading range is a highly likely outcome of the bull micro-channels breaking down on various time frames.

A Shot at the Fundamentals

I still ponder the question, why are interest rates falling and economically sensitive stocks weakening? Three issues likely form the heart of this current market dissonance.

First, inflation is devastating the purchasing power of individuals. My wife has been in Greece for five months, but for a few days when she came home, and all of us had to return when her father took an unexpected turn for the worse. My wife is a very conscientious consumer. Yesterday was her first trip to the grocery store since this past February. Needless to say, she was shocked by the prices.

Inflation is a deadly, ominous hidden tax that angers me to my core and hurts those at the bottom of the economic ladder the most. This administration promised to help those at the bottom, not hurt them. One only needs to look at the price of housing, gasoline, and food to ask the question, how are the current policies working for the poor and middle class?

If the Fed isn’t in the pocket of the current administration, it will begin the process of reversing its dubious, inflationary monetary policies soon, and the markets may be anticipating the end of the liquidity party.

Second, the extended unemployment benefits end in September. As well, many of the mortgage, rent, and other debt relief programs will expire soon. The transition out of all of these subsidies has to be a concern to current market participants.

Finally, we are experiencing a third China Virus wave with cases increasing daily. As it is called, the Delta strain is apparently quite virulent, highly contagious, and vaccine-resistant. More masks? More lockdowns? More shots? Who knows, but sometimes the fear of something is worse than the something itself, at least for the financial markets.

Any combination of these fundamental factors could be the catalyst for a one to three-month, intermediate correction, long overdue in this market. I patiently await this correction to aggressively deploy capital. I have done this too long to plunge in near a top, no matter how good it looks. We just got stopped out of the XLF, even though we kept the position small and bought it after nearly a 6% correction and double bottom off the trading channel. So just because something is low, does not mean it cannot go lower.

Conclusion

This week, I have shifted my stance from “neutral to bearish” to “bearish.” Really, my opinion does not matter. The change in my position telegraphs that I want to go back into the market on a good downdraft instead of a minor one. I need to see a true correction and pivot on the daily chart to garner my interest in a swing position.

While we should get a short-term turnaround or bounce today or tomorrow, that may be a time to raise cash. Markets rarely form an upside down “V” top. Usually, they will climb back up one more time and either test the old high or fall slightly short of it, if the intermediate correction is finally underway. The evidence is mounting that the trend is (at the very least) transitioning sideways, if not into the anticipated full-blown, intermediate correction.

During this period of unusually high risk these past few months, I have been quite satisfied with day trading, as opposed to holding overnight positions. Watch the Morning Outlook for Day Traders, updating three times daily, for guidance. However, paper trade for a while before you plunge into day trading. Day trading has its own foibles to challenge us.

I am understandably frustrated that stops and sell signals were taking place on the two days I was stuck in airports and on airplanes traveling, though I did my best to drop a few paragraphs to keep you updated. I was on a single, direct plane flight for nine hours on Friday between Frankfurt and Denver when the most critical market violations occurred.

What I find difficult (and have these past few months) is that while our swing-trading sell triggers have been excellent, the need to turn around and reenter on a buy signal almost instantly and in such an overvalued market is not so easy to execute, especially having just exited a few days earlier. If that becomes necessary here, it won’t be easy either. Every step higher in this market involves increasing and considerable risk.

If you still hold some XLF, you can see if we get a turnaround today with the bulls, but I have learned over the years to be rigid with my stops even though we get whipsawed once in a while. The XLF was doing all it should until Friday, when it got caught up in the widespread selling. That was my one fear in taking the position.

Patience is a virtue here. As always, be careful.

A.F. Thornton

View from the Top Down – 7/19/2021