After an 11% rally in the S&P 500, trading floors seem to be echoing "buy the dip" mantras. It would seem investors do suffer from the-memory-of-a-goldfish syndrome! It was not long ago, prior to Christmas week, that we were trading around 2600 on the S&P 500, tested that level three times, only to break it disastrously towards the end of December.
Rather than cheering the start of a new bull market, perhaps we should see this rally as a much-needed "oversold" bounce. We have just recouped that loss. Let's face it, the trends are still horrendous and we are back flirting with the 2600 level.
Wind back two weeks. Other than bullish comments from Mnuchin, Fed Powell turning slightly more dovish (more in line with the rates market), and overly enthusiastic tweets by Trump on trade talks going "very very well," one would be forgiven for asking "has anything really structurally changed?"
We are still facing a global economic slowdown, as witnessed by various countries' PMI, ISM and Industrial Production data over the last few weeks. In addition, we have also had about sixteen companies guiding lower ahead of their fourth-quarter earnings updates. The casualties include Apple (AAPL) , FedEx (FDX) , Macys (M) , American Airlines (AAL) , to name just a few. Needless to say, Q4 2018 earnings will not be pretty. That may have been more or less priced in, but the market will wait to hear on the guidance and outlook commentary for 2019. The jury is still out.
The "easy" bounce from December lows is done, now comes the harder part. For the market to break higher from here, we need some substantially incremental positive news to overcome these resistance levels. We should not ignore that the market has undergone some serious technical damage: big trend lines broken, moving averages displaced, lower highs and lows. This sort of situation does not heal itself in just a matter of days, or months even. It is possible, like in 2015/2016. If the central banks were to embark on a massive global stimulus path (a paradigm shift), a proper break higher is possible. That is yet to be decided, but for now, we do not know the outcome of U.S./China Trade Wars and may not hear anything on this until March. Until then, the market is fair play.
Q4 earnings start in full speed this week, with about 22 financials reporting, including bellwethers like JP Morgan (JPM) . The market will need to digest all these numbers to get a firm handle on what the earnings cycle looks like in 2019. Full-year 2018 saw stellar earnings growth progression year over year, thanks to President Trump's tax cuts, which seem to be fading now. According to bottom-up consensus estimates for 2019, S&P 500 reached a peak of $179 in August, but currently stands at $171, implying about 6% growth year over year. Not terribly exciting, especially taking the risks into consideration.
We are the top end of a downward-trending range for a host of stocks, including the S&P 500. Earnings and economic reports including further liquidity withdrawals will likely cap the market, for now. Furthermore, the machines and computer algorithms are probably salivating at an opportunity to go short and lean on the market once again after this 11% bounce from lows! In an absence of positive momentum, the index can easily move back towards 2400 and retest its lows.
Investors are still nursing their wounds from October last year, and not rejoicing as much from the bounce in December. The chronic problem facing most investors is that they focus on their P&L -- and not on the merits of the investment itself: cheap can always get cheaper. As the old adage goes, "Don't trade your P&L." It is not about how much you need to make back, but about how much more you can lose. This is a harsh reality to face when one needs to cut losses, but a process that is much needed to preserve capital and time your entry back in optimally.