Equities Topping – Breakdown Ahead?

With the S&P 500 at 2464, it continues to hover within 1% of a new all-time high. Yet, internally, the market is deteriorating with more and more stocks moving below their 50-day and 200-day moving averages.

Throughout 2017, the story of the rise in the S&P 500 has been a story of a fairly narrow list of very large-cap stocks that have contributed to nearly half of the index’s strong advance. Many of those stocks are very close now to breaking down through key support with the S&P Index also flirting above key levels. For the S&P 500 (last at 2463.36 as we pen this update), a couple of key levels to watch are the 2458 level, which is close in support, and then just below that is the 50-day average at 2454.50.

A break below 2454.50 would be short-term bearish and would turn up the credibility on the potential that the S&P 500 has been moving in a large distribution top over the last few months. It is potentially a head and shoulders pattern, but would still need a downside break down to confirm that outcome. Until the S&P breaks below the 100-day average (at Point c on the chart above) at a reading of 2431.15 AND key horizontal support at approximately 2410, it would be too soon to call a top is in place. Mind you, that does not mean that the entire structure right now looks incredibly vulnerable. In addition, any time we are talking about the potential for a serious break down in the stock market, we always want to watch several different indices for confirmation.

Another good index to watch is the Wilshire 5000, where a potential top is even easier to read. Here, any move below the 50-day moving average at 25,490.80 (with the index last at 25,553.88, down -22.37) would be a warning, while a close more than 1% below 25,100 would strongly suggest that a major stock market top has been seen and the primary trend is undergoing an intermediate change in trend from up to down.

On most of these indices, key medium-term momentum indicators are now close to zero, and any further near-term decline, (a pick-up in selling pressure from here) would take them below zero very quickly. That would be more bearish confirmation.

Other stock indices that should be watched closely for signs of weakness over the next few days are the NASDAQ Composite, the Amex Technology Index (XCI), and the Russell 2000 (IWM).

For the NASDAQ, initial support is the September 5th low at 6,334 and then below that at the 100-day moving average at 6205. The absolute “must-hold” zone for the NASDAQ is the area of the August 10th and August 21st lows, essentially the horizontal support zone between 6170 and 6190. If that is violated, the odds will be high that the bull market in stocks is over.

The Amex Technology Index (XCI) chart strongly suggests that a sharp downside move is close at hand. It has been moving in a broadening pattern for several weeks and the support zone at 2280 is also a critical level. A break below 2280 on this index would send a huge red flag for the market as a whole.

Finally, on the Russell 2000 ETF, the IWM, watch 137.48 and then 133.75 for downside confirmation. If the current rally is healthy, we believe the Russell should not be retracing more than half of the recent advance. A move below 137.48 would, therefore, be a short-term caution signal while any break of the larger horizontal support at 133.75, which dates back many months would be clearly a big negative.

The stock market advance is exceptionally extended as even the head of Goldman Sachs noted the other day. From Lloyd Blankfein earlier this week, “Goldman Sachs Group Chairman Lloyd Blankfein on Wednesday sounded a warning about the markets, saying that some of what he sees “unnerves” him. Mr. Blankfein said the current market environment “doesn’t feel like tulip-bulb-mania,” a reference to the famous speculative bubble in the Netherlands in 1637, but was nonetheless concerning. “Things have been going up for too long,’ he told attendees at a Handelsblatt business conference in Frankfurt. ‘When yields on corporate bonds are lower than dividends on stocks? That unnerves me.’”

Mr. Blankfein may not be aware of it in numerical terms, but his gut feeling is absolutely spot on. In the chart below, we see the S&P 500 with its 100-day moving average in the top clip and a Time Span Counter in the bottom clip.

The chart on the bottom counts the number of days the 100-day moving average has been in an uninterrupted advance, and right now we are at 325 trading days and counting. This is closing in on the two prior longest streaks ever seen which measured 352 and 360 days respectively. Bear in mind, that because the 100-day average is medium-term in length, it takes a substantial move just to turn it down. This strongly implies that, bottom line, the stock market should be very close to at least a 5% to 10% correction, if not the start of an outright bear market. With Korea, tariffs and the tax reform all coming up in the days ahead, there is likely zero room for disappointment. Add to this the fact that we are in a strong down seasonal time frame in the 3rd quarter of the seventh year, and traders and even long-term investors should have a game plan on how to dial down portfolio risk. Prior long bull markets have had a distinct tendency to end with very sharp price declines. Discipline is key, perhaps now more than ever.

Have a good weekend,

For more information on Salem Partners or their services, please go to https://www.salempartners.com.

Disclosures: Salem Partners Wealth Management and the Salem Capital Markets Outlook is sent to our clients and friends to share some of our views on current markets. Materials in this report are copyrighted and proprietary to Salem Partners Wealth Management (SPWM) and may not be reproduced or distributed without our expressed written approval. All rights are reserved.

Past performance is no guarantee of future results. All opinions expressed constitute Salem Partners Wealth Management’s judgment as of the date of this report and are subject to change without notice. This information should not be used as the primary basis for investment decisions.

It should not be assumed that any security transactions, strategies, holdings or sectors discussed were or will be profitable, or that future recommendation will be profitable or will equal the investment performance discussed herein. Investing in equities and other securities involves risk to your principal. Individual client account performance will vary and no guarantee of any kind is made as to the results that may be obtained from using these reports. These reports are impersonal and do not provide, nor are they intended to provide, individualized advice or recommendations for any specific audience or portfolio.

To the maximum extent permitted by law, Salem Partners LLC, Salem Partners Wealth Management and the authors of these reports disclaim any and all liability in the event that any information, commentary, analysis, opinions or advice contained in these reports prove to be inaccurate, incomplete or unreliable, or result in losses on any investment. The information provided in these reports is obtained from sources which the author believes to be reliable. However, the author has not independently verified or otherwise investigated all such information. Neither the author nor SPWM guarantees the accuracy of any such information.

About the Author