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September 21, 2020

Stock Market: Trend and Momentum Turn Down

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To summarize the current situation, the short-term trend and quite possibly the medium-term trend of the stock market has turned down after the peak on 9/2/2020. The long-term major trend is debatable. Seasonal tendencies have turned quite bearish. Neither the fundamental nor the technical indicators are offering hope that this decline is likely to end this month. So, a defensive approach remains most prudent.

Since the S&P 500 intraday peak at 3588.11 on 9/2/2020, this stock-price index fell -7.49% over the past 11 trading days and now is back down below its widely-followed 50-day Simple Moving Average for the first time in nearly 5 months since April, 2020. Trend-followers take that as a sell signal.

Previously, trend-followers had been buying the most popular technology stocks simply because their prices seemed to go up most days. History shows that trends can change very abruptly, however, and that trend changed after 9/2/2020. The most popular stocks suddenly became the weakest stocks, falling more steeply than they previously rose. Out of the blue, bullish traders were losing money faster than they had made it. There is nothing quite like losing money to change the emotions of the trading crowd. Once burned, twice shy. Fear replaces Greed.

Before this trend change, this report stated: "The stock market appears overpriced and overbought.... Now, trend followers are chasing a relatively small number of stocks that have continued to rise in price. Narrowing market leadership often coincides with a market uptrend that is on its last legs, a warning of impending trend reversal.... And the old saying, 'Prices take the escalator up and take the elevator down,' means that prices fall faster than they rise."

For those who like the details, let us review a few of the more popular indicators that we monitor every day.

The S&P 500 price index closed below its widely-watched 50-day Simple Moving Average (SMA) for the first time since April. A close below the 50 SMA is recognized as a sell signal by many traders. The most popular momentum oscillators, RSI and MACD, both collapsed to their lowest levels since April. The bullish price momentum that was evident until 9/2/2020 appears to be broken.

RSP is an ETF composed of the S&P 500 stocks, with each stock given the same equal weight. That contrasts with the capitalization-weighted S&P 500 price index, which gives proportionally more weight to the stocks of large companies and less weight to the stocks of smaller companies. Note that as of 9/2/2020, RSP stopped short of its high in February, 2020, diverging bearishly from the S&P 500 price index. This suggests that a small number of large capitalization stocks had been driving the S&P 500 higher from March to early September, not a good sign. Currently, RSP remains slightly above its 50 SMA, so it is not quite as bearish as the capitalization-weighted S&P 500 price index.

The percentage of the S&P 500 stocks above their trailing 50-day SMAs fell to its lowest level since early July and is now below both the 50-day SMA and 200-day SMA, following previous bearish divergences.

The percentage of the S&P 500 stocks above their 200-day SMAs currently is not as weak as the percentage above their trailing 50-day SMAs. This 200-day breadth momentum indicator remained below its June and January highs when the S&P 500 peaked at a higher high on 9/2/2020, however, thereby demonstrating bearish divergence, which was an early warning of trend change.

The NASDAQ Composite Index closed below its 50-day SMA on Friday. Many traders recognize that as a sell signal. RSI and MACD fell to their lowest levels since April. Price is trending down, and momentum is confirming the price downtrend.

The cumulative daily net volume of advancing issues minus the volume of declining issues on the NYSE broke down below its 50-day SMA and 200-day SMA. Many traders recognize that as a sell signal. For 8 months, it languished well below its January high, indicating bearish volume divergence compared to the S&P 500 price index.

The all-issues A-D Line, which is the cumulative daily net number of all advancing issues minus the number of all declining issues on the NYSE, actually rose last week to finish slightly above its 50-day SMA. It peaked on Wednesday 8/12/2020 and failed to rise to a higher high on 9/2/2020, indicating bearish breadth divergence compared to the S&P 500 price index. Before Wednesday 8/12/2020, listed issues that are not common stocks had been carrying this data higher.

The common stocks only A-D Line, which excludes NYSE-listed issues that are not common stocks, offers a different perspective on breadth. By failing to rise above January and August 2020 highs on 9/2/2020, it indicated a worsening bearish divergence compared to the all-issues A-D Line (charted above) and compared to the S&P 500 price index.

The number of daily net new highs on the NYSE currently appears neutral between its 50-day SMA and 200-day SMA.

The Dow Jones Transportation Average rose to its highest daily closing price since 2018 on 9/16/2020, but the Industrial Average remained below its 29,551.42 closing price high of 2/12/2020. This indicates that the Dow Jones Averages are diverging from each other and have not confirmed a major bull market trend. The stock market is not in gear, with the Averages not pulling together.

Market participants try to anticipate economic conditions ahead, so market prices are leading indicators of economic conditions. Most of the known economic indicators lag market prices. Commodities that are sensitive to global economic conditions are giving contradictory signals. Copper is bullish at a 2-year high, but Lumber is bearish after collapsing since 8/28/2020.

According to the lagging reported economic data, the US economy contracted at a 31.7% annual rate from April through June, 2020, its worst drop on record. Federal Reserve Chair Powell said, "Output and employment remain far below their pre-pandemic levels. The path forward for the economy is extraordinarily uncertain and will depend in large part on our success in containing the virus. A full recovery is unlikely until people are confident that it is safe to reengage in a broad range of activities." The Federal Open Market Committee (FOMC) Meeting Minutes of 9/16/2020 stated, "The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term."

The global central banks' massive flood of new liquidity was an important driver behind the stock market recovery from March to September, 2020. The Fed and all the major central banks have been aggressively providing liquidity to the global financial system in an extraordinary effort to stem economic collapse. Over the 9 months from 9/4/2019 to 6/10/2020, the U.S. Federal Reserve increased its Total Assets by 90.59%. Total Assets have leveled off since June, the extreme growth rate diminished, and stock market momentum may be beginning to reflect it.

Seasonal tendencies based on past market history can be somewhat useful but are not as powerful as momentum and trend indicators. Tendencies turned quite bearish after Wednesday, 9/16/2020, and continue bearish for the rest of the month. September as a whole has been a losing month on average for the past 148 years, since 1871.

Our first priority is to protect and preserve your capital. We always carefully weigh potential rewards against potential risks when we consider any investment. This is not as simple as it may seem. When we analyze all the facts and details, the objective evidence is often mixed, with both positives and negatives, and often neither significantly outweighs the other. If the potential rewards do not significantly outweigh the potential risks, we reject that investment. Markets can be volatile, indeed extremely volatile at times, and long experience has taught us that it is better to be cautious in times of uncertainty than it is to take unwarranted risks that could result in substantial losses which could make recovery extremely difficult. At this time, we must agree with Fed Chairman Powell: the outlook is extraordinarily uncertain. That warrants caution. When in doubt, stay out. Better safe than sorry. And the old saying, "Prices take the escalator up and take the elevator down," means that prices fall faster than they rise.

Investor sentiment remained cautions this week, which is no surprise because sentiment follows price. Sentiment is a supplemental indicator that is less important than trend and momentum. It is a contrary indicator that is sometimes useful for counter-trend trading. Markets are complex adaptive systems that reflect the emotions of the crowd reacting to contradictory and incomplete information as well as changing decision rules. Prices tend to swing to emotional extremes of optimism and pessimism. When there is a great majority of bulls, few investors are left to buy, and rallies suddenly can fizzle and reverse. Conversely, when there is a majority of bears, few investors are left to sell, and short-squeeze rallies suddenly can appear seemingly out of nowhere--the bounce after the March 23rd low is a good example. Neutral and mixed sentiment tends to coincide with uncertain, indecisive markets.

$VIX, Volatility Index declined slightly last week. It appears neutral between its 50-day SMA and 200-day SMA. The historical range is 90 to 8.

!NAAIM, The National Association of Active Investment Managers long-side exposure to US equity markets fell to its lowest level since May, indicating a rapid swing toward caution. The historical range is 110 to -6.

!AAIIBEAR, the percentage of individual investors that are bearish fell slightly below its 200-day SMA, indicating a declining level of oversold sentiment. The historical range is 70 to 6.

!PCRATEQU, the Equity Put/Call Ratio sprang higher as stock prices fell, as usual. It has been below-average most of the time since mid April, however. It fell to 37-38 three times between June and August, its lowest levels in 10 years. It could take time to work off these extreme levels of overbought. The historical range is 134 to 22.

The CNN Money Fear & Greed Index fell to Neutral as stock prices declined. See http://money.cnn.com/data/fear-and-greed/

The full report offers clear and unbiased guidance on the following each week:
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Make no mistake, the ongoing global economic and financial crisis has not been fixed by any sound or lasting solution. History shows that the authorities will not protect you or give you any advance warning--but we will.

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Robert W. Colby, CMT,
is a consultant to institutional and private investors and traders, providing regular analytical reports, custom research services, and trading systems tailored to clients' objectives. Clients include the most successful traders and investors in the world. Robert is the author of The Encyclopedia of Technical Market Indicators, Second Edition, McGraw-Hill, 2003, which has become the standard reference for indicator and trading systems design. Previously, at several large Wall Street firms, Robert worked as a proprietary trader, technical analyst, and fundamental analyst. He also was adjunct professor at New York University and New York Institute of Finance, where he developed new courses on technical analysis and market timing.

Robert W. Colby is a Chartered Market Technician (CMT), an accreditation granted to members by the CMT Association (https://cmtassociation.org/) after demonstrating professional competence and ethics over a period of many years. Robert has been a member since 1980, and he strongly supports the CMT Association's high standards. He also supports the The Technical Analysis Educational Foundation (https://www.taeducation.org/about/), which works to have technical analysis included in the curriculum of major business schools. The CMT Association is the national organization of investment analysts, stock market analysis professionals, and certified market technicians in the United States.

 
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