EURUSD News by Simon Kazinsky on 08:45 Octuber 09, 2018 EST
We have been saying almost since the inception of Forex Status back in 2014 that the US stock market is overvalued while also stating, ad nauseum that trends can last longer than you can stay solvent if you dare to go against them. You may have to wait for a long time, even years, for the market to reflect reality. The US stock market is a paradigm of this very frequent frustration for traders.
As an example of this dichotomy where fundamentals and technical analysis differ is our Standard and Poors 500 technical report posted on the 09th of April 2016 as the index
was making a multi week low in the 2,500 region. Though the bias was fundamentally bearish the target for the next leg was set way higher in the region between 2,800 and 2,950, thus likely to post new all time highs, which is where we are now.
The reasoning was purely technical as the index had clearly bounced when testing a very long term moving average that had previously provided support. The target was also based on technical analysis as we will see below.
Chart from the S&P500 technical analysis post in April 2018
Trends should never be faded, even if fundamentals are gone trends can last for way longer for many reasons, being the main one that if investors are making profits with it they have no major incentive to stop doing the same over and over. Most of the capital invested in stocks
comes from institutional investors, pension funds, sovereign funds, etc. Huge pools of money that need to be allocated somewhere perceived as safe and likely to produce a reasonable yield every year. Changing course quickly for this transatlantic money vessels is impossible and it will be also impossible for fund managers to consider opposing the trend even if realistic assessments would advise to do so. These funds allocate their capital by set rules, being one of them the scores that rating agencies give to the investments in their portfolio.
As we saw in the case of Lehman Brothers rating agencies may have no incentive to reflect reality either. As simply explained in the movie "The big short" if a rating agency starts downgrading your company, bonds, etc, well, there are other rating agencies across the street more than willing to portray you in a more optimistic way for a handsome fee. Hence in 2008 bonds backed by mortgages that were already defaulting remained triple A for a while.
And so the trend that started following the 2008 financial crisis aided with the unprecedented stimulus provided by the Federal Reserve and all the other major central banks has been able to run and run to where it is today. But the problem is that we have run out of ammo as all the factors that have contributed to this rise are gone.
Fundamental factors that have contributed to the US stock bonanza have been:
- The FED and other central banks stimulus currently being rolled back.
- The creation of jobs, at almost full employment at present no further significant progress can be made.
- The Trump tax cut now fully priced in.
- The unprecedented levels and length of low interest rates which the FED and other central banks are now reversing.
- The one off repatriation of capital to US shores by corporations after the Trump tax reform.
- The low oil prices that are now only a memory.
As previously mentioned the fact that all fundamental factors contributing to the trend are now diminishing or gone is not reason enough to start fighting it. When all the conditions that have favoured the trend are gone the only thing that we can do is look at the chart and wait for a technical level to be reached and hope to see that price action is sensitive to it. This is exactly what has just happened in September.
An example of this technique where a trader will only start contemplating fading the prevailing trend based on the subsequent reaction to a technical level is the case of Bitcoin. The crypto currency was set to reach the moon in 2017 as we can see in its parabollic trajectory until a day in December when 1 bitcoin was traded for the very round figure of 20,000 USD. The market reacted violently to this level dropping back down to 14,000 and then briefly retesting the 20,000 2 weeks later. The rest is history as 1 Bitcoin can be bought today at around $6,500.
Our view is that the S&P500 is setting a very similar pattern that started with the sudden drop in January 2017 but that instead of reaching the 3,000 level which is now at arms length it has set a top at 2,941 just less than 10 points below the upper boundary of the target range we set in April.
We have been anticipating since April that the stock market would reach a top either by reaching the day that establishes a fibo series connecting the tops in 2000 and 2007, this would fall in July 2019, or the level that establishes multiple fibonacci relations between the lows of 2009, 2011, 2017 and the record high. That level is precisely at 2,941.
Of course there is a possibility that a further top could be set at or near the 3,000 mark or perhaps in July next year but the reaction we have seen this past week as the target was reached combined with how overdue the reversal is and the continuous deterioration of international relations around the world -US trade relations, UK brexit, EU/Italy deficit fallout- convince us that the catalysts are in place and the down move is in its very very early phase.
Short positions should therefore be gradually opened as the downtrend continues but short positions should also be gradually covered north of 2,930. The overall long term trend is still bullish and the long term support that will certify the up trend is gone if broken currently lies at around 2,690.
Providing that the 2,941 is the top and based on the notion that most of the rally since 2009 is based on shaky unhealthy ground the long term target is also set from a technical stand point. In this sense the 1,455 level constitutes not only a clean 50% retrace consistent with other previous major declines percentagewise but also the first higher top on this trend that was never retested. Based on previous down trajectories and supporting moving averages that are slowly moving up this level will be reached around April 2021.
Both the magnitude and the duration of this correction are consistent with other major declines in the history of the US stock market.
As an added bonus, if this prediction is right the top will go in history as being set exactly 10 years after the Lehman Brothers collapse.