The stock market’s rebound from what was the worst Christmas Eve on record for the Dow Jones Industrial Average in history has been nothing short of incredible—but markets may sour after a bullish stretch, some market technicians say.
At the end of trade Wednesday, the Dow
and the S&P 500 index
were just a hair’s breadth from a 10% comeback from their correction lows on Dec. 24, a span of just nine trading days. The current rebounds are historic outliers: Since World War II, there have only been 12 other declines of 15% or more within the span of three months that were immediately followed by a rally of 10% or better in 10 trading days or fewer, according to Bespoke Investment Group.
How much longer will the rally last? Not much longer, according to several technical indicators, which show that U.S. equities have reached so-called overbought conditions in the medium term.
Tony Dwyer, chief market strategist at Canaccord Genuit, says markets are stretched, citing the moving average convergence divergence, or MACD indicator, a measure of momentum for stocks.
Though usually deployed to find buy signals for individual stocks, when the broad market is showing overwhelming momentum to the upside, it acts as a contrary, “sell” signal. A particularly high read can mean that the potential for a sell-off or downturn is high.
Dwyer said over the past 10 days, the indicator showed 71.1% of S&P 500 components displaying rapid momentum to the upside, while also pointing out that the market has only breached the 70% mark five times since 1990.
“All five instances occurred after a rapid reflex rally in prices off a low,” just as we have seen in recent weeks, according to Dwyer. “In four out of the five instances, the ultimate low occurred after the signal, suggesting that the recent low in December will be at the very least retested prior to a move to new highs in 2019.”
In other words, in 80% of the instances since 1990 when markets have seen such a similarly broad swath of the assets displaying such rapid momentum to the upside, as we do today, the equity benchmarks put in new lows shortly thereafter.
Tom Essaye, president of the Sevens report, warns clients in a Thursday note that the technicals don’t look good for stocks in the medium term, even as he sees the short-term path of least resistance going higher.
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“The most discouraging part about this now three-week rally is that it has occurred on relatively thin volumes,” he wrote. He points on that 25.6 million S&P futures contracts changed hands in the two weeks before Christmas, while just 15.1 million were traded during the final two weeks of the year. “Even though it was options expiration, the high-volume selloff underscored the fact that sellers have had much more conviction than buyers over the last several weeks,” he wrote.
Essaye picks 2,560, 2,599 and 2,651 as key resistance levels that stocks could struggle to break through, absent significant upbeat news on the macro or earnings fronts. “A lot of volume traded hands in this area, and big volume often acts as a magnet for the market when conditions become overbought or oversold like they are now.”
Meanwhile, Chris Kimble, founder of Kimble Charting Solutions points out that by looking at the monthly average of the S&P 500, the December selloff caused the S&P 500 to break through its nine-year rising support level and its 12-month moving average. “The S&P 500 did become oversold on a short term basis,” Kimble wrote in an email. “But as you can see, despite the decline, monthly momentum remains lofty.”
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