Another tough week for markets, in a Thanksgiving shortened trading week. Negativity and negative sentiment abounds but right now is not the time to get bearish on stocks.

Pundits are bearish

There is no shortage of worries, or yet more calls from pundits for tougher times head for the stock market.

Market commentary this past week has not made for cheerful reading:

As the stock market and economy are set to skid, Goldman says cash will be king – MarketWatch

Hedge-fund boss who predicted ’87 crash says get ready for some ‘really scary moments’– MarketWatch

Morgan Stanley Keeps Announcing the Arrival of a Bear Market, and Now Stock Prices Are Starting to Agree – Fortune

The Dow may drop another 2,000 points before the stock market selling is done: CNBC CFO survey – CNBC

Bank of America sees market decline next year – CNBC

Cramer: “You’ll wish you sold at these prices’ if the Fed hikes rates in December.” – CNBC

Remember – the worst time to short a market is when things look their bleakest.

Sentiment still looks very bearish

The weekly AAII survey released suring the week showed a continuing decline in bullish sentiment. Bullish investors are now down to 25.3%, verses 41.2% just two weeks ago. Bearish investors are now at 47.1%, the highest level since February 2016. Sentiment indicates we’re closer to a bottom (at least in the short term) than a top.

Now, imagine for a moment that you’ve been sunning yourself on a tropical island for the past two months. Far away from the reaches of mainstream news media. If somebody handed you a note saying “The S&P 500 just closed 10% below its all-time high”, would you fly into a panic and expect a nasty bear market was imminent? Neither would I.

Earnings continue to rise, even as stocks fall

96% of S&P 500 stocks have reported earnings for Q3 2018. Including estimates for stocks that have not yet reported points to a 29% increase over earnings for Q3 in the previous year.

At the same time, S&P are projecting a further 2% increase for the next quarter (Q4) and 12% by Q3 2019.

S&P 500 earnings continue to grow
S&P 500 reported earnings and forecast earnings are rising

This is in contrast to the sharp falls in earnings that we saw in Q4 2000 and Q3 2007, preceding the last two major market downturns.

Economic data too has remained consistent with moderately strong economic growth into 4Q18.

History informs us that when earnings are growing and the economy is growing, corrections tend to be just that – corrections. We would need to see earnings start to fall and/or economic data weaken appreciably for bear market fears to be fully justified.

Interest rate cycle

Aside from US-China trade war concerns, one of the other chief fears among investors is the interest rate cycle will kill the bull market. While this may ultimately turn out to be true, it seems we are still a long way away from the point in the interest rate cycle that should cause anxiety.

In the last rate hike cycle from 2003 to 2007, the Fed hiked rates 17 times, going from 1% to 5.25%. The cycle before that from 1994 to 2000, the Fed hiked 14 times with the Fed Funds rate finishing the cycle at 6.5%.

So far this cycle the Fed has hiked 8 times and the Fed Funds Rate sits at 2.25%. I think we are still several hikes away from the point where anxiety about Fed activity becomes warranted.

And now for the bad news

The bad news is some serious technical damage has been done over the past few weeks.

S&P 500 chart. 2600 is the key level to watch to get more bearish
S&P 500 daily chart

The S&P 500 has now spent 4-5 weeks below its 200 day moving average (200 DMA – the orange line in the chart above), which in turn has flattened out.

Beware reading too much into a flat 200 DMA

A FLAT 200 DMA actually has very little informational value. Securities will tend to respect moving averages with some slope/gradient but flat moving average lines indicate a weak trend/no trend and markets to not tend to respect them.

That said, securities do perform better when they are above a rising 200 DMA than when they are below a falling 200 DMA. But don’t looks for the 200 DMA to tell us very much until it regains some slope…in either direction!

So far the S&P 500 has held its October low. The key level to watch on the S&P 500 now is 2600. A close below this level opens up the likelihood of greater downside ahead.

What we need to see now is a series of higher highs and higher lows for this uptrend to resume. Given the flat 200 DMA, the market may now establish a trading range that could last a while.

NASDAQ looks worse than S&P 500

The NASDAQ is faring worse, having taken out its October low this past week. We have now seen three lower highs and lower lows. Last week’s low must hold or a retest of the Feb low at $150 in the QQQ becomes the greater probability.

QQQ Chart. QQQ ETF has taken out its October low. Last week's low must hold or things will look very bearish
QQQ daily chart

That the NASDAQ looks worse shouldn’t come as a huge surprise when you consider that many of it’s leading stocks – FAANG stocks for example – have outperformed the S&P by hundreds of percentage points, so of course these stocks had further to fall.

Looking at a weekly chart of the NASDAQ 100 Index…if this thing really is going to roll over and die, should expect a rally back to the 7200 level to complete a head-and-shoulders before things get worse.

NASDAQ chart - should rally to around 7200 from oversold levels even if things get more bearish in the future
NDX weekly chart

The market is short and due for a bounce

The 10 day moving average of the equity Put-Call Ratio does a pretty good job of identifying market turning points. Peaks in this ratio typically accompany market troughs.

Put-Call Ratio signals a low in the S&P 500
Equity Put-Call Ratio
S&P 500 chart
S&P 500

The ratio currently indicates a very high level of short exposure/hedging activity. When “everyone” is short, we run out of sellers and the market tends to go up. This is the scenario I see today.

Conclusion

I expect the stock market is at or near at least a short term bottom. However, the trend is unclear and until it becomes clearer – one way or the other – I will keep my position sizes smaller than normal and look to trade both sides of the market.

The market could be about to enter a wide trading range that could last for some time. In order to call a resumption of the bull market, we need to see the S&P 500 and the NASDAQ challenge and take out their all-time highs. A succession of higher highs and higher lows would be a good start.

A breach below 2600 on the S&P 500 will give me cause to reassess and likely start giving at least a short-to-medium-term downtrend the benefit of the doubt.

Until next time, good trading.