Our last several updates have covered the implications of the two most probable outcomes for the rally off the December 24, 2018 low. In more detail than usual for these brief updates, we made the case that December 24, 2018 was likely a key reversal date to keep in mind going forward, and nothing that has happened since changes any of those observations.
The notion of a key reversal day has now played out along the lines our updates anticipated. So now I want to review the importance of the S&P-500 resistance levels, which were discussed in recent updates, as those are looming as extremely important in terms of increasing client wealth, or protecting it as the market yields more clues about the strength, or weakness, of the underlying supply and demand for stocks going forward. This is NOT going to be some esoteric academic exercise, but a real financial world challenge to position client portfolios properly on the risk spectrum. Failure to execute this drill properly may significantly penalize client wealth in terms of lost opportunity costs, or expose clients to an assault on their accumulated profits, and/or wealth, as a faux rally rolls over into an accelerating, and progressively violent, bear market decline, as hordes of global investors attempt to rush to the safety of cash, when they realize they have been trapped in the recognition phase down in a big bear market.
The first chart above shows that the S&P-500 has now exceeded, by a good margin, the 62% Fibonacci retracement level of the October to December 2018 decline. This is a very positive development, and implies that the S&P-500 2888 resistance level just ahead may be tested next. I thought the rally may need to consolidate its gains before an assault on the S&P-500 2888 level, but with TATY, a supply and demand indicator (See Second Chart below), spiking to 152 this past week, the rally may have enough strength to begin an assault on the S&P-500 2888 level sooner rather than later? Regardless of the timing, the price is now entering what I consider a danger zone, where the bulls must continue to generate supply and demand numbers sufficient to power the rally higher. The probabilities have favored the bull case, and that will continue to be the true as long as both the price, and a series of supply and demand indicators, demonstrate the ability to paint out higher highs and higher lows.
So Gregory what are you going to do with my wealth? The probabilities continue to favor the bull case, so for now we will hold our current long positions, especially since many of those were purchased last year at this time, which means they are beginning to qualify for long term capital gains tax treatment. All my clients have profitable positions, so yes the tax treatment is an important consideration, even though nominal tax rates are now at historically low levels. However, probabilities are subject to change, and should they begin to move in a direction more favorable to the bear case, then prompt action will be required. Why? The next paragraph covers the extreme risks implied by a mature bear market perhaps on the cusp of a swiftly accelerating terminal decline.
I am content to leave market predictions to those, which think the have the tools and skill to be successful at that most risky of endeavors. However, consideration of the worst case for client wealth must always be taken into the calculus by Alexander and I, as a continuing exercise in client due diligence. The perceived danger zone represented roughly by S&P-500 2888 to the previous all-time high at 2941 is where the bull, or bear, case will very likely emerge as a reality. If the bulls continue to generate confirming supply and demand numbers, then the odds of an accelerating rally will increase sharply, as under-invested money managers chase the rally higher. Please note that valuations are meaningless in these situations, because under-invested professional investors are subject to being terminated by their firms for such an error, which are costly to clients in terms of lost opportunity. However, if the bulls fail to generate objective evidence that they are still in control of the market, then the odds will begin to gravitate toward the bear case, and the bear case in this situation represents huge potential risks to investor wealth.
If the danger zone gives way to the next leg down in a very big bear market, then the potential wealth penalty may be applied swiftly, and in unrelenting fashion. If the October to December 2018 decline was just the prologue in a big bear overture, then the next leg down will likely contain a violent vortex of volatility, as panic and mindless program selling become the order of the day. It matters not how good a leader a corporate CEO is, nor the strength of the franchise, nor the strength of the balance sheet when that corporation is a part of an index, which is being sold in size by panicked investors on the global exchanges, or in the futures market. When the program sellers launch their sell algorithms, then selling begets selling, and the selling continues until the bear trend finally exhaust itself. Such is how mature bear markets do business. Thankfully, for the time being the mature bear case remains a lower probability, but still an active probability subject to revision higher.
The bottom line is we got the “tell” of the December 24-26, 2018 key reversal date right, and now the bigger, and much important challenge, is to correctly solve of the resistance (danger) zone conundrum as well. To do so will require us to properly apply our proprietary tools, and all our experience, to a potentially very dangerous situation, and then to have the courage to act adroitly in the best financial interests of our clients. A difficult mission in all aspects, but especially the latter, as most in this challenging business are prone to fail the test of courage at critical moments due to lack of confidence in their methodology and/or preparation.