At the end of 2018 the stock market fell about 20%. Could it happen again this year?
Let’s use a chart to explore the issue. Please click here for an annotated chart of S&P 500 ETF
Note the following:
• The chart shows when the stock market fell about 20%.
• The chart shows the Arora buy signal given on Christmas Eve, which turned out to be the bottom of the decline.
• The chart shows that since the 20% drop in the stock market, the market has recovered all of the drop and more.
• The chart shows the breakout. This is a positive.
• The chart shows that the move after the breakout has been small. This is a negative.
• The chart shows that resistance is nearby. This is a negative.
• Historically, the pattern the chart is tracing has a high probability of breaking out above the resistance level to the upside. This is a positive.
• The chart shows that the relative strength index (RSI) is overbought. This indicates that the market is vulnerable to the downside.
• The chart shows that the volume is typically higher on down days. This is a negative.
• The first big difference between last year and now is Federal Reserve policy. Last year the Fed was tightening its monetary policy. This year the Fed is easing. This is a positive.
• At The Arora Report, we monitor economic indicators from 23 countries. Our focus is on leading economic indicators. This year the leading economic indicators are weaker than they were last year. This is the second big difference from last year. This is a negative.
• Earnings are the single best determinate of the stock market in the long term. Earnings season is in full swing, and earnings are slowing. So far, however, earnings are better than expected. This is a positive.
• The trade war presents more uncertainty this year.
• There are impeachment proceedings against President Trump this year.
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What does it all mean?
Investors ought to pay attention to Arora’s Third Law of Investing and Trading: “Making investing and trading decisions based on probabilities is the only realistic and profitable approach.”
The probability of a 20% drop in the near term is about 35%. Of course, this probability will change based on corporate earnings reports and the outcome of the phase-one trade deal with China. Specific cash levels, hedge levels and positions to buy and hold that we provide to our subscribers are based on the probability given above.
Investors should keep an eye on popular stocks such as Facebook
The price action in these stocks is bullish. Apple’s
stock is a benchmark for a number of reasons, including its presence in China. On the surface, price action in Apple is extremely bullish for the stock market. However, a close look at segmented money flows in Apple stock show that most of the buying is coming from the momo (momentum) crowd. Therefore, the bullishness in Apple should be taken with a grain of salt. Please see “Momentum investors are now buying shares of Apple, Amazon and Netflix.”
Semiconductor stocks are often early indictors. Currently, popular semiconductor stocks such as Intel
are showing remarkable resilience.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.