Cataclysmic action in the fourth quarter left investors shell-shocked, as U.S. stocks plummeted and over 90% of dollar-based asset classes fell for all of 2018.
Macro monsters from trade wars, Brexit, slowing economic growth, a slump in global property prices, political uncertainty, yield-curve inversions, deficit explosions, technical breakdowns, etc., are lurking everywhere, leaving investors blindfolded while they try to navigate highly volatile market waters in search for a safe destination in 2019.
As we learned in 2018, extremes can become more extreme, long-term trends matter, patterns matter, divergences matter, technical disconnects matter and now we’re dealing with the aftermath and their implications.
My main market message for 2019: Pay close attention and stay fully informed. There are a lot of complex moving technical and macro pieces driving markets and the global economy that make for a foggy outlook for the year ahead.
Wall Street tends to focus on a destination when it projects higher year-end target prices. Indeed, as in 2018 and in 2008, Wall Street is again projecting higher prices for this year. While higher prices are always a possibility, my focus in this report is on the journey rather than the destination, as I expect wild price swings within the 2018 range (2,340-2,941 points in the S&P 500 Index
) and possibly a much lower range still to come.
My aim here is to highlight some select macro- and technical-risk factors that have both negative and positive implications for markets.
Let’s start with the ugly. The biggest risk for investors: That it’s different this time — and not in a good way. Why different? Because we are facing the prospect of a major market top in place and a coming recession, but this time central bankers have a lot less ammunition at their disposal compared with previous economic cycles. Meanwhile, debt is higher than ever, by far. Here we are 10 years into an expansion and global growth has been slowing dramatically, and markets are highly stressed.
The European Central Bank (ECB) is still on negative interest rates, the Bank of Japan (BOJ) is still printing and the U.S. Federal Reserve, instead of taking advantage of the opportunity during the growth recovery, embarked on its slowest interest-rate increase cycle in history. During Janet Yellen’s tenure, the Fed tinkered much too cautiously, missing the opportunity to build a larger buffer to deal with the next downturn. Only three months after confidently projecting a four-rate-hike schedule for 2019, recent market turmoil already caused Fed Chairman Jerome Powell to cave and send dovish jawboning signals to markets on Jan. 4, the timing of which is following the historic script I outlined in “The Ugly Truth.”
The reversal in yields and the breaking of the bull market trend in context of an unemployment cycle reaching its historic cycle limit overtly raises the possibility that this bull market is over and may repeat the cycle of previous market tops.
If this is so and a recession indeed unfolds into 2019/2020, much lower risk ranges must be considered in the months and years ahead:
The 2000 top saw a recession following into 2001, with markets bottoming in 2002. The total retrace from the lows of the 1990 recession to the 2000 top ended at the 0.618 fib. An equivalent technical move now would imply an eventual move back toward the 2000 and 2007 highs with the 0.618 fib sitting at 1,535. For reference: The 2008 financial crisis reversed more than 100% of the advance from the 2002 lows to the 2007 highs. So if anyone thinks such a move is impossible, it indeed is the historic reversal record of the past two bubbles.
Except this time central banks have much less ammunition.
And be clear: Wall Street is not publicly forecasting this technical scenario. But let me also point out that Wall Street did not forecast the 2002 and 2009 lows either.
If you view this potential scenario through the lens of supply and demand, perhaps the biggest concern here is one of demographics. Baby boomers are entering retirement age. Many are looking for security and have experienced the pain of the financial crisis and most likely will not want to gamble on living through another massive downturn. Indeed, we saw record redemptions in December following record passive-ETF inflows in early 2018. As market liquidity has been dropping steadily over the past year, we just witnessed the brutal impact of redemptions on prices during one of the ugliest Decembers in recent market memory. It serves as a major warning sign.
Now, before everyone panics and expects immediate doom and gloom, let me state clearly: Even if there is a top in place and markets are turning into a full bear market, know that even bear markets offer wide price-range opportunities, even to the upside. Hence, my focus is on the technical journey, as opposed to a specific destination at this juncture.
The full facts have yet to reveal themselves, and I will address a few of those below.
Note this correction was no ordinary correction; in fact, it was an extraordinary correction, and I will highlight this with a chart of the $BPSPX, the bullish percentage index of the S&P 500:
Note that in December, $BPSPX hit levels not seen since the financial crisis, a selloff deeper than the 2011 and 2015/2016 corrections. Hence, I want everyone to be clear on this: This was a major, massive correction that stopped precisely at the weekly 200 moving average (MA), a key historic pivot.
As I outlined just before Christmas in “Imbalance,” markets were overshooting to the downside and targeting key support levels and, hence, a larger rally into January was to be expected. Indeed, the action so far has been closely following the 2000/2001 script. That rally back then ultimately resolved to the downside.
Really important: During the three previous occasions of markets correcting into the weekly 200 moving average (2008, 2011 and 2016), markets engaged in a double-bottom process, meaning that the lows were retested at some point with a lower low. During the bull market trend, these retests served as major lows before embarking on a journey to new highs.
In 2008, the subsequent rally off of the retest produced a lower high that led to an eventual breakdown below the weekly 200 MA.
Hence, for 2019 this is a crucially important technical dynamic to watch in the weeks and months ahead.
Retest or not, given vast oversold conditions, there are reasons to expect large rallies in 2019 as long as markets can sustain price moves above the weekly 200 MA.
Let’s look at some of those reasons.
One of the key reasons is the VIX
In “Yearly Candles,” I highlighted the importance of yearly charts and technical reconnects off historic extensions. Charts of the NASDAQ 100 Index
and the FAANG stocks were just too extended to the upside and demanded a technical reconnect. Those reconnects look much better now, but still haven’t fully reconnected and, hence, the potential for a retest of December lows with a new low is a very probable scenario at some point in 2019.
But it is the VIX that specifically suggests rallies to come and an at least a temporary calming of the waters will also be part of the market’s makeup in 2019:
Note in every single year, bull market or bear market, the VIX will at some point not only reconnect with this yearly 5 EMA (exponential moving average), but it will also dip below it. We saw that even during the bear markets in 2001/2002 and 2008/2009. As of now, in early 2019, the VIX has yet to reconnect with its 5 EMA. So here’s a prediction: VIX will calm down at some point in 2019 and even dip below its 5 EMA.
But be clear: The landscape for volatility has changed:
As you can see in the chart above, VIX has broken above multiple wedge patterns. In January 2018 it broke above its 2016/2017 wedge, then based above it during the summer, then broke above its new wedge in October before forming a bull flag. This January we saw the VIX retreat back to its bull flag pattern as markets rallied, aiming for MA reconnects. So be clear: Volatility has structurally broken higher and will likely remain elevated for quite some time. As long as it remains in bullish structures, it can technically resume its path higher.
For now markets are seeking balance and wanting to reconnect with key moving averages. As of now, the S&P 500 remains below its weekly 100 and 50 MAs and its daily 50 and 200 MAs. At some point in 2019, markets will want to reconnect with these moving averages; hence they will be key to watch. Note all these moving averages, as well as open gaps above, will pose resistance. As do any broken trend lines. In the chart above I also indicated some reversal fibs that may be of interest.
So be aware there will be a lot of resistance ahead, not only technically, but also supply-driven as there are plenty of trapped buyers above who seek to break even. Those resistance points will be a key challenge for markets in 2019, and they may prove turning points if a bear market is to unfold.
Only a sustained close above the daily 200 MA and the weekly 50 MA can give investors comfort that perhaps a major low is in play and markets can head to higher pastures.
Let me crystallize the market’s dynamic challenge for 2019 using one key stock as an example: Apple
Last week the company’s stock found support at its 0.50 fib near its weekly 200 MA. During the recent bull run, the weekly 200 MA was key support, along with a heavily oversold weekly RSI (relative strength index), which then produced rallies into the weekly 50 MA before going to new highs. Currently that weekly 50 MA is at 187. Hence, technically speaking, a move toward that MA reconnect in the months ahead would constitute a technical rally target.
The company just issued a major revenue warning and cited the trade war with China as one of the key reasons for its struggles. How much of the global slowdown has been exacerbated by trade wars I’ll leave for others to debate, but be clear: Companies such as Apple would benefit greatly from a positive resolution to the trade war. And it’s not just Apple. As Trump economic advisor Kevin Hassett said last week:
“There are a heck of a lot of U.S. companies that have a lot of sales in China that are basically going to be watching their earnings be downgraded … until we get a deal with China,” Hassett said on CNN. “It’s not going to be just Apple.”
And that’s exactly right. Hence, a positive trade war resolution would likely spark a major rally and could serve as the trigger for a move up to the weekly 50 MA on Apple, for example.
Failure to reach a positive conclusion, of course, would leave the negative overhang and could very much be the trigger for the S&P 500 to break below its weekly 200 MA, as outlined earlier. Hence, trade wars are key to watch in 2019.
But Apple is also symptomatic for larger issues beyond trade wars. Fact is, the company’s growth in iPhone sales, its main product line, has stalled. People are upgrading phones in slower intervals as phones have become more expensive and the incremental advances in technology are simply too little to offer a compelling reason to upgrade every year.
What’s that say about the technology cycle in general? The good news for Apple, and other players may, of course, be 5G, which is just around the corner. As coverage will become available in the next few years, it will offer a major reason for people to upgrade. But that’s not happening in 2019 yet.
Fact is, slowing global growth is not only driven by trade wars; slowing growth is structurally driven and, hence, it is critically important for investors to keep a close eye on larger macro drivers.
In a perhaps good news/bad news sort of way, one of the key items to keep an eye on is Industrial Production (IPI):
As similar as charts are to previous market tops, IPI has so far not shown a reversal, which makes the current market breakdown inconsistent with previous market tops. Yield curves aside, a coming recession would be signaled by a reversal in industrial production. So keep a close eye on December’s data when it comes out. Should we see a break lower, it may be an ominous sign. A blip? Or the beginning of something larger? We will need to see and evaluate the evidence as it comes in. As long as data points such as industrial production can show a positive trajectory, the recent correction may set equity prices on an upward recovery trajectory.
As I said at the outset: Pay close attention and stay fully informed. There are a lot of moving parts here, but they will provide plenty of opportunities for active investors/traders.
In January we will see corporate earnings reports and outlooks, which will be closely scrutinized. The fourth-quarter market correction has taken some of the excess out of markets as valuations and market caps have dropped dramatically in some cases and key market signal indicators still show vastly oversold conditions.
Buybacks remain a factor in markets as a source of liquidity, but they were clearly not enough to prevent the breakdown in markets, as redemptions overwhelmed that remaining source of artificial liquidity. The Fed just sent a dovish signal indicating policy makers stand ready to react and adjust their balance-sheet reduction schedule, and markets rallied hard on this.
In summary, my outlook for 2019: Technical considerations suggest a coming reconnect with key moving averages in the weeks and months ahead as well as an at least temporary calming in the VIX. However, a retest of the December low is a distinct possibility at some stage. A sustained break below the weekly 200 MA would set markets on the historic path of previous market tops. To the extent that a resolution in trade wars can bring about a resurgence in optimism and delay a global recession, markets may find a way to break above the key moving averages, setting up for a positive 2019.
A horrific outcome for market participants would be if even a positive resolution to trade wars cannot change the structural business cycle realities and a global recession ensues as evidenced by slowing production, revenues and earnings. And then all of us would be confronted with the scariest unknown monster of all: A coming downturn with central banks never having normalized policy and a lot less ammunition in their coffers compared to previous downturns.
Sven Henrich is founder and the lead market strategist of NorthmanTrader.com. He has been a frequent contributor to CNBC and MarketWatch, and is well-known for his technical, directional and macro analysis of global equity markets. His Twitter handle is @NorthmanTrader.