Tuesday Looked a Bit Like a Waterloo Moment for Bulls: Market Recon

 | Jan 17, 2018 | 7:57 AM EST
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"Survival can be summed up in three words - never give up." -- Bear Grylls


It all seemed perfect. Too perfect, coming out of a three-day weekend. U.S. equities stormed out of the gate. The Dow Jones Industrial Average crossed the 26,000 mark for the first time. The S&P 500, which is a much bigger deal in the equities world, traded above 2800 for the first time as well. These levels, it would seem, were a simply a step too far, at least on this day.

On another field, a very long time ago, Napoleon Bonaparte sensed opportunity. Late in the day of June 18, 1815, Wellington's center had been exposed. Or so it seemed. The fight had swayed back and forth. Casualties were very heavy. Bonaparte still had uncommitted to this fight, his Imperial Guard -- to be more specific, his "undefeated" Imperial Guard. What was left of the entire Armée du Nord rallied around that Guard. They pressed ahead. Victory was close.

Ride of the Valkyries

It was at that point, a late entry into the day's affair was made by Dutch General David Hendrik Chasse. With the general came fresh cavalry and artillery. Wellington and his coalition had performed as well as could be expected, but this event is what turned the tide. Napoleon was to be defeated. You may not know who Marshal Michel Ney is. Every soldier stands in awe of his performance during the Grand Armée's retreat from Moscow three years earlier.

Ney put it bluntly: "I saw four regiments of the middle guard, conducted by the Emperor, arriving. With these troops, he wished to renew the attack, and penetrate the center of the enemy. He ordered me to lead them on; generals, officers and soldiers all displayed the greatest intrepidity; but this body of troops was too weak to resist, for a long time, the forces opposed to it by the enemy, and it was soon necessary to renounce the hope which this attack had, for a few moments, inspired."

That was it for the French Emperor. Napoleon would be exiled and die within six years. It was sellers that showed up in U.S. equity markets on Tuesday morning just as victory had seemed assured, not Dutch cavalry. Energy and material stocks led the way lower. General Electric (GE) -- a holding of Action Alerts PLUS, which Jim Cramer co-manages as a charitable trust -- started the day out in the hole after disclosing a $6.2 billion charge that appeared to somehow take the firm by surprise. For what it's worth, I added to that position late in the day. I would not follow me into this one if I were you, as that name has begun to test my skills as a trader, much the way Apache (APA) did last year before ending up as one big happy story.

There really are a myriad of forces that had traders and algorithms seizing profits in Tuesday's trade, rather than hang on for dear life. The threat of a government shutdown is obviously a short-term negative that cannot be completely discounted. This impact could easily be seen across the defense and aerospace industry as well as in infrastructure building type names. The political: Steve Bannon. The geo-political: North Korea. Over-extension? Yeah, that could be it, or maybe the inflows of cash are merely slowing down. This would have to be expected at some point.

The Bear Case

It was only in yesterday's Market Recon that I warned both on Bitcoin, and on the increase in the flashing of the plastic by U.S. consumers. We touched on how this increase in the use of revolving credit was being targeted on necessities, and not the kinds of things that folks find fun or interesting. Later in the day, it became apparent that Bitcoin was under intense pressure, and The Street's Kinsey Grant reported that according to S&P Dow Jones and Experian, the December 2017 composite rate of consumer credit defaults increased by two basis points month over month to 0.91%. The bank card rate increased by a whopping 16 basis points to 3.44%. Yes, children, there are monsters under your bed.

So, it was on a day that saw 1,082 new 52-week highs across the New York Stock Exchange, Nasdaq, and the NYSE MKT (previously known as the American Stock Exchange, AMEX) that the markets would suffer their most alarming reversal in quite some time. I looked for a telltale sign that this was it for the bull. There was no gravestone doji screaming at day's end to let us know that the game was over. Quite simply because I feel that the game is, indeed, not over. Monetary conditions are normalizing. With that normalization will also come a return to volatility. There is no cute way around this. There are still many reasons to stay long the equity space for now.

Rules for Survival

Remember, you are not in this game for life. Well, you may be in the markets for life, but you are never married to any one position.

1) What's the single most important thing I teach? Diversification, right? Your best defense is the avoidance of placing too many eggs in one basket. This seems so elementary, yet so many fail to follow up on this.

2) Target Prices. You do see what the crowd is doing, don't you? Every day, analysts that have been right on specific stocks are raising target prices in those names. I want you to do the same. Don't want to sell? Fine. At least raise your target price. Never wander in the forest without some kind of map. That's how you get lost. That's how you lose money. Why is that? Because when you raise your target, you also increase your panic point, almost guaranteeing yourself profits in your best performers even when markets turn against you.

3) Sell Something. Jim Cramer likes to say: "No one ever got hurt by taking a profit". He's absolutely right. I have had my own retail trading account since I was 13 years old. This is the first lesson that my Dad taught me. Jim also teaches that profits are not real until they are "realized". You're not up anything until you turn it into money. Guess what. That is the second lesson my Dad taught me.

4) Spider Sense. We all have it. This is when, not for any really good reason, a situation, or position makes you nervous. Do you know what I do when a position stresses me out? I get rid of it. Your current P/L in the name does not matter. Up or down? It is not where you entered that matters once you have paid for it. The only thing that matters at that point is where you close the position. Nobody needs the stress of a festering sore that will not leave you alone.

The Bull Case

Could markets go lower? Of course. However, earnings season is only beginning, gang. I believe that most of our reporting companies are going to post nice numbers for both earnings and revenue growth. Then, in their respective conference calls, most will have something positive to say regarding economic growth and tax reform. After that, the analysts that cover these forms will be forced to raise guidance. See where I'm going?

By the way, as discussed in yesterday's Market Recon, valuations are just not as elevated as folks think, once these analysts do actually increase guidance. I told you yesterday that the S&P 500 is now trading at "just" 18 times next year's earnings. This may seem high, but it's down from 20 times (last month), despite the market's surge. Now, growth may falter. Earnings may fail. That's just not where we are in the cycle just yet, in my opinion. Oh, there's one more thing.

Stock Shortage

It's simple. Valuations in fact deserve to be higher than what most consider to be historical norms. It's not just the perverse monetary conditions, although that is indeed a significant part of the story. As those monetary conditions tighten, liquidity will be removed from the economy, and markets will have to stand on their own. Will valuations ever return to historical norms? Of course not. Any of my fellow talking heads who think so are just not putting in the homework.

There are just too many coins flowing into the jukebox, and not enough songs to play. It's no secret that across the entire marketplace, many firms (across all industries) have been buying their shares back in the secondary market, retiring, and reducing the number of shares outstanding by measurable percentages.

There has also been, on top of mergers and acquisitions, less of a drive for start-ups to go public since the financial crisis. The result of this? Let me tell you a story. The Wilshire 5000 Total Market Index was created in 1974. It was meant to give the broadest picture possible of equity performance, by including nearly every publicly traded U.S. company that trades on a U.S. exchange as well as over the counter. The index was so named because in 1974, there were approximately 5000 such companies in the U.S. The index has never been held to a specific number of components as time passed, but the number 5000 was always left in the title of this index.

By 1998, the number of publicly listed U.S. companies hit an apex of 7562. Get that? 7562!!! How many stocks make up the Wilshire 5000 today? That's right, 3492. So, in other words, investment money seeking an equity market home (much more than in 1998) has seen the available choices dwindle by nearly 54% in those 20 years. That's before we even get into the reduced floats of individual firms. Still think historical norms matter all that much? Yeah. Me neither. Apples and oranges, gang.


Oh, and by the way, ASML Holdings (ASML) just ripped the cover off earnings expectations while announcing a new share buyback program. That's a real positive that will likely be felt across the semiconductor space this morning. Huzzah.

Charts of the Day: The S&P 500 (SPX)

A quick look at a one-year (and 16-day) chart shows persistent relative strength and a wildly healthy looking moving average convergence divergence (MACD). Money Flow has recovered from a late-year swoon as well. What also become apparent is, though we could start this chart in 2009, over the past year Fibonacci levels have worked superbly on nearly every pullback.

Yes, Tuesday's reversal felt somewhat disarming. That said, the extreme right of the chart had started to look like a hockey stick. That we do not need.

Focusing on only the move higher that began in early December, we see that even yesterday's volatility did not violate our Pitchfork model. In fact, the model was strictly obeyed by the algorithms. Guess what? That central trend line breaks, and the Pitchfork hands you almost precisely the same level as does a Fibonacci level laid over the same chart.

As you can see, the market can allow for prices as low as the 2730-ish level without breaking even a single thing, technically. Fear? No fear. Never fear. We rock. You can also see how support rises into February, should the index fail to break yesterday's lows in short fashion.

The Fan Model allows for a little more wiggle room as far as support into February is concerned than does the Pitchfork. You do get the idea. Failure to break to the downside quickly only strengthens support. The guys who are paid to write the algos are paid by guys who read the same charts we do. They see all the same levels that we do. No promises, but for those willing to put in the work, this makes markets more predictable than ever. What was that? I can't hear you. That's right, we rock.

Sarge's Trading Levels

These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.

SPX: 2806, 2796, 2785, 2773, 2765, 2759
RUT: 1597, 1589, 1573, 1567, 1557, 1549

Today's Earnings Highlights (Consensus EPS Expectations)

Before the Open: (ASML) ($1.06), (BAC) ($0.45), (SCHW) ($0.42), (FAST) ($0.45), (GS) ($4.95), (USB) ($0.87)

After the Close: (AA) ($1.25), (KMI) ($0.18), (SLM) ($0.19).

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