Watch For a Sudden Shift In Character in the Next 2-4 Weeks.

U.S. equity markets have rallied strongly since the beginning of October. During this time, there has been much written about the weakening global economy. Economists from Goldman Sachs are warning of the “third wave of the 2008 financial crisis” here. Last night, Chinese trade data showed a drop in imports of 20.4% in September versus the year-ago period, one of the largest on record, further highlighting a weakening Chinese economy. Furthermore, Chinese exports were down 3.7%, indicating a weakening global economy. Blackrock has suggested here that bonds are a safer investment right now than stocks. These assessments suggest a longer-term downshift in the future return expectations of U.S. equities.

Short-term, I believe there is a growing risk of another downside move in equity markets, particularly over the next two weeks. The recent rally in U.S. equities has taken various markets back toward their 200-day moving average, a widely followed trend barometer and, a possible reversal point. These markets are now overbought on a short-term level. The NASDAQ has completed a Fibonacci 61.8% retracement of the entire drop from the July 20, 2015 high. While the Dow has broken above its September 17th recovery highs, the NASDAQ, the S&P 500, the KBW Banking Index, the Dow Transports, and the Nikkei 225 have not. Several indices, such as the Nikkei, have already broken the lows set in August this year, which confirmed our earlier analysis suggesting this possibility. However, major U.S. indices have thus far avoided a break below August lows, and as markets have rallied, sentiment has improved among individual and professional investors. The character of the recent rally from August lows and specific patterns in play continue to suggest vulnerability to a resumption of the decline that began in the May-July period. An eventual move to and through the August lows is very possible. In particular, my time models have identified a window extending from approximately October 7-Oct 12 and centered on October 14 as a point in time when a notable change in the character of price action is possible. Per my models and global macroeconomic analysis, U.S. equities are vulnerable to a swift downdraft into month-end. More importantly, a break of the August lows is possible in the weeks to come, with further downside into November and December.

I am monitoring the pattern shown below, among others. The left chart is the current day Dow Jones Industrial Average, and the right chart is from many years ago. Note, the blue rectangular boxes and the price action contained therein. In this template, the Dow Jones Industrial Average is vulnerable to peaking in the timeframe mentioned above. A descent that approaches or breaks the August lows in the next few weeks could follow and steepen into yearend.

Numerous longer-term metrics such as investor allocation to equities suggest stocks are expensive and exposed to a downturn, whenever that may be. As always, price confirmation will determine any action we take. However, I remain vigilant against a sudden shift in character in U.S. equities over the next two to four weeks. If such a shift does not occur, I will work to identify the next likely direction.

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Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. Accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.

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