Anyone who has followed my financial related work on this site probably knows I’ve been bearish the US stock market. And not just the FAANG stocks, I’ve been calling for major widespread downside potential. My original thesis still applies to now and I think that overall, the selloff is going to get much worse later this year.
Knowing that, it may come as a surprise that I believe the best course of action right now is to not panic dump all of our stocks on Monday when the market reopens. Though I’m expecting a deeper correction to ultimately continue, assessing the current status of the market suggests a short term rally is likely for a couple of reasons.
- Federal Reserve Stimulus
- Technicals Screaming Oversold
The Coronavirus is not the main reason stocks were eviscerated this week. It might simply be the pin that pricked the bubble. To be sure, it may seem as though Wall Street suddenly figured out that the second largest economy on the planet being closed for business is highly detrimental to the supply chains of all of the multinational giants in the US stock market. Still there is another theory.
“People didn’t suddenly wake up Feb 19 and decide the coronavirus was an issue. Whereas the Fed saying assets valuations were elevated and they were going to taper repo interventions… that’ll pull the rug from under any Ponzi scheme.”
David Brady is terrific trader and generally provides great economic commentary. If you buy David’s theory, and I’m leaning he might be correct, it’s highly likely a return to Federal Reserve balance sheet expansion pushes markets back up. Just yesterday, Fed Chairman Jerome Powell signaled future Fed action if things get worse.
“We will use our tools and act as appropriate to support the economy.”
What “tools” does the Federal Reserve possess? About two. It can lower interest rates and it can increase the balance sheet. “Increase the balance sheet” is economic speak for print money. This money printing is precisely what inflated the stock market to the historic valuations we saw just two weeks ago.
Despite what political jawboners have been telling us, the economy is not strong. It has been fragile for some time. And this crash has been long overdue. But again, don’t panic. There should be an opportunity to get out at better prices after a bounce in the near future. Technically speaking, the broad market has been vigorously oversold. I realize that most of the readers here might not have a terrific handle on technical analysis when trading so I’ll do my best to walk you through what I’m seeing in the current S&P 500 setup.
First, let’s establish that the overall trend until recently has clearly been up. But there was cause for concern from a technical perspective even before this past week’s selloff. The Gray arrow in the top Right corner is pointing to an RSI divergence at the recent all time highs. Though new highs were made, there were achieved on weaker momentum to the upside. This is typically a sign of a reversal on the horizon. The selloff produced a massive oversold stock market. The blue arrow in the bottom right corner is highlighting a deeply oversold daily chart. The last time the market was this oversold on the daily was the December 2018 correction. That RSI low is highlighted with the orange arrow in the bottom left corner. The move from that point was nearly a straight up recovery. Additionally, the daily candle from Friday is showing bullish for two reasons. There is a long wick on the bottom of the candle showing bulls were active as supply became available. Not only was the close well off the lows but it was also above the open. So even though the market closed lower Friday, it was a productive candle for market bulls.
As someone who respects the technical indicators, I view a short term bounce before a deeper correction as highly likely. Especially if the Federal Reserve uses the “tools.” Of course, I could be wrong. Again, I’m not a professional money manager and I have no certifications. That’s why I’m providing this at no cost. None of this is investment advice. I’m just sharing my view on what the future might bring. Allocate your portfolio however you see fit. Best of luck out there.