The big bounce in the market following Tuesday's election raised hopes that the ugly corrective action that occurred in October had come an end. The irony was that nothing had really changed from a fundamental standpoint. The China trade issue was still unresolved, interest rates and inflation were still an issue and now there was the increased likelihood of political battles between President Trump and the Democratically controlled House.
The main justification for the strong action was 'gridlock is good.' This is overly simplistic take is questionable, but it is always foolish to argue with price action -- even when the reason for it doesn't seem very logical.
The question we face, now that the post-election euphoria has worn off, is whether the fundamental worries that caused so much selling pressure will become major problems again, or whether the positive technical action will continue.
The bullish technical argument is quite easy to make. Most stocks went through a significant correction in October and became oversold, they found a bottom, there was strong follow through and now the trend is back up. There are some issues with being extended and overbought in the near term, but after some digestion, there is the tailwind of positive seasonality into the end of the year.
The bearish fundamental argument is also quite easy to make. The trade issues are still unresolved, and Democratic control of the House may make it even harder to resolve them. The Fed is still on a very hawkish course and will continue to raise rates, especially since the jobs news continues to be so strong. Markets around the world are still a mess, with the U.S. market being by far the best. Political storms have not mattered much in the past, but they are sure to intensify.
The major positive is that the economy is strong and now that there is gridlock in place in Washington, there will be no changes to tax policy, deregulation or other issues that have created the foundation for the best economic growth in a long time. The bears say the recession is coming, but there are no signs of it yet and the Fed is not acting like it is concerned.
It is a battle between positive price action and negative fundamental arguments. If the bears are right, it should be reflected in the charts quite quickly. But we can't be too fast to conclude anything from a pullback at this point.
If the bearish narrative starts to take hold once again, we will see the price action deteriorate very fast. The bounces won't hold, there will be lower lows and there will be talk about retests and support levels.
While Wednesday's follow-through day has a good track record of success, I am concerned about the headwind of the fundamental issues. The rally really had questionable justification and the Fed indicated quite clearly yesterday that it is going to continue to raise rates and is not concerned about the market correction that occurred in October.
The key here is to not anticipate, but to watch the price action and react as it develops. I am concerned about the ability of this bounce to hold and am going to err on the side of defense.