By Pete Biebel, Senior Vice President
One old adage of market behavior is that many of the steepest rallies are rebounds in continuing downtrends. Picture Paul Bunyan bungee jumping. The market’s plunge in December stretched it to near the breaking point. The snap back rebound since Christmas has been the steepest rally in a long time, steeper and faster than would have been expected. Another old adage is that the market never does what “everybody” expects it to do. So, while many expected the rebound to recover something between 30% and 50% of the previous decline, last week’s continuation of the rally lifted the averages well beyond that range. While not many traders expected the major indices to rebound beyond their declining 50-day moving averages, all the major indices and many of the minor ones managed that feat last week.
A third old adage is that rebounds in continuing downtrends will be strong enough to convince participants that the rally is going to continue. We seem to be getting very near that point. The negative momentum at December’s low was so extreme that a retest of that low was a strong possibility. But now the size and speed of the market’s post-Christmas rally has greatly decreased, though not yet eliminated that possibility.
The first couple weeks of the rebound covered a lot of ground. Then, last week, instead of pausing to catch its breath, the rally chugged higher. After a brief pause on Monday, the averages marched higher each of the next four days and ended the week with gains of about 3%.
On both Tuesday and Wednesday, the rally stalled at the bottom end of my expected rebound target range near the 2625 level of the S&P 500 Index (SPX). SPX again failed to move beyond that level through the first several hours of trading on Thursday. Early that afternoon, The Wall Street Journal reported that the Trump administration was planning to roll back some of the tariffs imposed on Chinese imports. SPX rocketed higher on the news, from near 2620 to 2645 within a matter of minutes but eased back into the 2635 area late in the day when the accuracy of the report was brought into question.
Friday morning brought news that the Peoples Bank of China had injected a record 1.16 trillion Yuan into its financial system. Markets in China ripped higher. Averages in Europe had gains of one to two percent coming into the U.S. opening. Stocks in the U.S. gapped higher and went on to add to their gains through the day. SPX ended the day and week a bit above 2670, near its high of the day and week.
The market’s strength over the last two weeks, rebounding well beyond standard, expected levels, has driven much of the late-December bear population into hibernation. The steepness of the rebound probably shouldn’t be a surprise given the steepness of the December decline. And, the fact that the rally overshot the widely expected rebound targets probably shouldn’t be a surprise in retrospect. Given the popularity of those target levels, the market was likely to either fall far short of reaching them or rally well beyond them.
The next two weeks should provide some clues as to whether the market’s 3 ½-week rally is something more than a rebound in a continuing downtrend. Of the 17 trading days since Christmas, the major averages have closed near their highs of the day on more than two-thirds of those days. One of the first signs we might see of a returning bear is the averages closing near their lows of the day and/or giving back big chunks of early gains later in the trading session. A second bad omen would be if the indices see follow-through selling after breaking below nearby key levels. For SPX those levels would be the 50-day moving average (near 2625) and the 2580 – 2600 range.
Old Paul probably had a pretty dim view of bungee jumping at that first low point, but the snap back up greatly improved his perspective. Likewise, the better-than-expected post-Christmas rally has provided investors with a far better vantage point from which to assess the current level of risk in their portfolios.
- If your portfolio was well hedged with a level of cash that enabled you to do some bargain hunting in late-December, that’s great, but you might want to consider some short-term profit taking.
- If you were well-hedged but did no buying last month, that’s also great, but now is probably not a good time to be a buyer.
- If you were well diversified but unhedged, you probably weren’t too happy at the December lows. The rally has restored a little cheer, but it might be a good idea to establish a plan to reduce risk if the market gives signs that the downtrend is resuming.
- If you were not well diversified and the December plunge severely damaged your portfolio value, then thank goodness for the big rally. But, rather than a time to relax and think everything is fine, now might be a good time to improve diversification and to establish a plan to reduce risk.
- Whether or not you were well diversified, if you closed out some or many positions in late-December, now is probably not a good time to rush back in. Give it a few weeks to see if the averages can hold on to these rebound levels.
The new Earnings Season ramps up this week with many more big-name and high-profile companies scheduled to report. As we saw last week, any hints of significant news regarding the path of the U.S./China trade war can spawn fast, one-way market reactions. We should expect government shut-down and tariff-related headlines, both good and bad, to continue to pop up. Unfortunately, the timing of such news is random; there’s no telling when the next rumor or headline might rock the market. The real message in any such news is how the market reacts to it. So far, the market reaction has been to rally on good news. Over the next few weeks, we’re likely to see a day on which the market gets good trade war news but fails to hold the rally that the news inspires. If and when such a day occurs, that would probably be another bad omen.
|Monday 1/21/2019||Martin Luther King Jr. Day|
|Tuesday 1/22/2019||Existing Home Sales, SAAR||5.320mm||5.240mm|
|Wednesday 1/23/2019||Richmond Fed Manufacturing Index||-8.0||-3.0|
|Thursday 1/24/2019||Initial Jobless Claim||213K||217K|
|PMI Composite Flash||53.6||54.2|
|Leading Indicators, M/M||+0.25||-0.1%|
|Kansas City Fed Manufacturing Index||3||2|
|Friday 1/25/2019||Durable Goods Orders, M/M||+0.8%||+1.8%|
|Durable Goods Orders, ex Transportation, M/M||-0.3%||+0.1%|
|New Home Sales, SAAR||565K|
Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market.
Please remember, diversification cannot guarantee a profit nor protect against loss in a declining market.