Retailers reach peak sales during the holiday season and relatively weak turnover in the subsequent period. They are aware and well prepared for this cyclicality. A similar relationship holds for the business cycle. Although the pattern fluctuates less regularly, business cycles unfolded since modern record-keeping and probably even before that. Business cycles are among the most reliable recurring patterns.
Evidence that several degrees of trends are coming to an end builds up. Our macro outlook shows that the global economy enters into a stage that was historically at the epicenter of tipping into a recession. Sentiment and position indicators reveal exuberant expectations among market participants. The 20DMA CBOE Equity P/C ratio below shows, for example, an extreme reading relative to the past decade. It confirms many other gauges that show bullish extremes – a condition that has been typically observed around larger degree tops historically.
We isolated the relevant missing link to the short-term trend already. Our early December 2019 macro outlook concluded that “recent momentum is likely to carry the S&P 500 along a volatile path higher” before the wheels come off. The rally that started in October 2019 remains the only bullish factor that is intact. Meanwhile, it developed blow-off top characteristics, which are similar to what we witnessed in early 2018. Tech was the initial driver of the most recent rally and small caps joined the party soon after that. Both sectors are in the higher risk camp. This hints to further increasing risk inclination among market participants, which is another observation that has been typical near cyclical highs.
The short-term trend within the darker orange channel became stretched and is losing strength. A break of the red-dotted line, as well as the darker orange trend channel, will be the first pieces of evidence for a larger degree reversal.
Our outlook has not changed. We expect the market to encounter a negative surprise soon. Market participants, both retail and professional, have been conditioned to buy every dip and disregard the fundamentals. The party continues until they figure out that the emperor has no clothes. If everyone waits until the last moment to exit, that obvious exit point will be narrow and likely lead to a very big price drop. Most likely, this will happen rather sooner than later. The end of January may take U.S. equities to a junction that reveals additional signs of liquidity draining up. It may not be relevant to every investor. However, the time has come for swing traders to prepare for some more substantial short exposure. The bears are sneaking quietly around the corner – and they are starving!
*****The underlying analysis has been shared with our clients in greater depth during the past few weeks.*****