With the impressive rally off the lows the S&P 500 has now managed to make an important break back above its long-term (12-month) moving average. If you’ve been reading my ongoing updates for the better part of this year, you’ll know that this was the third warning sign I was watching for to help gauge the likelihood of a market peak and onset of a major bear market.
As shown in the red circled regions below (click image to enlarge), the S&P 500 failed to break back above its long-term moving average in 2000 and then again in 2008 in confirmation that we had seen a major peak and were now heading into a protracted decline.
The other two warnings signs indicated in the chart above still remain in place. That is, a divergence between the S&P and its relative strength index (RSI) and a major MACD sell signal that occurred in June of this year prior to the August correction.
Given the above and the current price action of the market, there are a number of possible outcomes—let’s break them up into a bullish and bearish case.
The Bear Case
The technical divergences and MACD sell signal remain in place, dragging the S&P 500 back below its long-term moving average in confirmation that we are in the beginning stages of a bear market.
This case has been made recently by many on our show. See the following interviews/articles for reference:
- Eric Hadik Sees Major Turn in Gold, 2016 Market Crash
- Technician Tom McClellan: Bear Market Trend Should Last Until Next April
- Robin Griffiths Sees Developing Bear Market and Long-Term Shift to Asia
- Michael Lewitt: Beginning Stages of a Bear Market; Talk of Negative Interest Rates Point to Increasingly Desperate Situation
- Louise Yamada: Major Sell Signals on All Indices
The Bull Case
On the flip-side, there are those who contend that we are merely witnessing a correction in an ongoing bull market—though with the potential to head lower still—and higher highs ultimately ahead of us.
Given how negative sentiment is toward the stock market, especially after the August correction, it is not surprising that this view has been harder to find. That being said, there have been some notable names on our show that make this contention: Dan Wantrobski (see here), Ralph Acampora (see here), and Martin Armstrong (see here).
Whether you agree with his points or not, Lee Cooperman at Omega Advisors also gave his 7 reasons for market upside:
1. This would be the first market peak that occurred without one Fed tightening. He says on average, the market went up for 2.5 years after the first rate hike.
2. Bear markets come due to recession, overvaluation, hostile Fed, or a geopolitical event. Those don't really seem to be present, with the caveat of the last one.
3. Markets usually peak during euphoria and he doesn't see any signs of that.
4. The stock market has already corrected recently.
5. What's the alternative to stocks... bonds yielding 2% or cash earning zero?
6. There's enormous substitution taking place of debt for equity. Corporations are announcing big buybacks and that supports the market.
7. Valuation is reasonable
So, as usual, the experts are divided. What’s an investor to do? Along these lines, Chris Puplava, Chief Investment Officer for PFS Group, noted last month:
Financial market volatility will likely persist heading into October until seasonal forces help bring about a possible year-end rally. If this scenario plays out, it will be important to see whether US and global economic growth improves, both alleviating market fears and leading to a resumption of the bull market. If the opposite is true and we see risk measures deteriorate further, preservation of capital will be much more important as the likelihood of a structural bear market increases.
One of the key areas to monitor going forward will be the credit markets. Higher stock prices should be confirmed by an improvement in the credit space, as RenMac's Senior Technical Analyst noted on our show last week (see here).
The Bloomberg Financial Conditions Index (which combines yield spreads from US money markets, equity markets, and bond markets) is one of many useful indicators to track the health of the credit markets. As you can see below, it diverged from the S&P 500 starting in 2014 and went negative along with the market in late August. It has since moved back to positive territory and is not showing the same level of deterioration that marked the 2007 top.