Authored by Sven Henrich via NorthmanTrader.com,
2019 Market Outlook
The cataclysmic action of Q4 left investors shellshocked as stocks plummeted and over 90% of US Dollar based asset classes ran a negative return for 2018 going against all Wall Street forecasts. Macro monsters from trade wars, Brexit, slowing growth, a slump in global property prices, political uncertainty, yield curve inversions, deficit explosions, technical breakdowns etc. are lurking everywhere, leaving investors blindfolded while trying to navigate highly volatile market waters in search for a safe destination in 2019. As we learned in 2018: Extremes can become more extreme, long term trends matter, patterns matter, divergences matter, technical disconnects matter and now we’re dealing with the aftermath and their implications.
My main market message for 2019: Pay close attention and stay fully informed. There are a lot of complex moving technical and macro pieces driving markets and the global economy that make for a very foggy outlook for the year ahead.
Wall Street tends to focus on a destination in terms of seemingly always projecting higher year end target prices. Indeed again, as in 2018 and in 2008, Wall Street is again projecting higher prices for this year. While higher prices are always a possibility my focus in this report is on the journey rather than the destination as I expect wild price swings within the 2018 range (S&P 500 2340-2941) and possibly a much lower range still to come.
My aim here is to highlight some select key macro and technical risk factors that have can both negative and positive implications for markets.
Let’s start with the ugly:
The biggest risk for investors: That it’s different this time and not in a good way. Why different? Because we are facing the prospect of a major market top in place and a coming recession, but this time central bankers have a lot less ammunition at their disposal compared to the end of previous economic cycles while debt is higher than ever by far. Here we are 10 years into an expansion and global growth has been slowing dramatically and markets are highly stressed.
The ECB is still on negative interest rates, the BOJ is still printing and the US Fed, instead of taking advantage of the opportunity during the growth recovery, embarked on its slowest rate hike cycle in history. During Janet Yellen’s tenure the Fed tinkered much too cautiously missing their opportunity to build a larger buffer to deal with the next downturn. Only 3 months after confidently projecting a 4 rate hike schedule for 2019 recent market turmoil already caused Fed Chair Jerome Powell to cave and send dovish jawboning signals to markets last Friday, the timing of which is following the historic script I outlined in The Ugly Truth.
In my December warning I outlined 6 specific signs to watch out for, one of which was the bull market trend line. That trend line broke in December along with numerous others I highlighted in Shattered Trends:
The reversal in yields and the breaking of the bull market trend in context of an unemployment cycle reaching its historic cycle limit overtly raises the possibility that this bull market is over and may repeat the cycle of previous market tops.
If this is so and a recession indeed unfolds into 2019/2020 much lower risk ranges must be considered in the months and years ahead:
The 2000 top saw a recession following into 2001 with markets bottoming in 2002. The total retrace from the lows of the 1990 recession to the 2000 top ended at the .618fib. An equivalent technical move now would imply an eventual move back toward the 2000 and 2007 highs with the .618 fib sitting at 1535. For reference: The 2008 financial crisis reversed more than 100% of the advance from the 2002 lows to the 2007 highs. So if anyone thinks such a move is impossible, it indeed is the historic reversal record of the last 2 bubbles.
Except this time central banks have much less ammunition .
And be clear: Wall Street is not publicly forecasting this technical scenario. But let me also point out that Wall Street did not forecast the 2002 and 2009 lows either.
If you view this potential scenario through the lens of supply and demand perhaps the biggest concern here is one of demographics. The baby boomers are entering retirement age. Many are looking for security and have experienced the pain of the financial crisis and most likely will not want to gamble on living through another massive downturn. Indeed we saw record redemptions in December following record passive ETF inflows in the early half of 2018. As market liquidity has been dropping steadily over the past year we just witnessed the brutal impact of redemptions on prices during one of the ugliest Decembers in recent market memory serving as a major warning sign.
Now before everyone panics and expects immediate doom and gloom let me state clearly: Even if we have a top in place and markets are turning into a full bear market know that even bear markets offer wide price range opportunities even to the upside. Hence my focus is on the technical journey as opposed to a specific destination at this juncture.
The full facts have yet to reveal themselves and I will address a few of these below.
Note this correction was no ordinary correction, in fact it was extraordinary and I will highlight this with a chart of the $BPSPX, the bullish percentage index of the S&P500:
Note that in December $BPSPX hit levels not seen since the financial crisis, a sell off deeper than the 2011 and 2015/2016 corrections. Hence I want everyone to be clear on this: This was a major massive correction that stopped precisely at the weekly 200MA, a key historic pivot.
As I outlined just before Christmas in Imbalance markets were overshooting to the downside and targeting key support levels and hence a larger rally into January was to be expected, indeed the action so far has been following closely the 2000/2001 script. That rally back then ultimately resolved to the downside.
Really important: During the 3 previous occasions of markets correcting into the weekly 200 moving average (2008, 2011 & 2016) markets engaged in a double bottom process, meaning that the lows were retested at some point with a lower low. During the bull market trend these retests served as major lows before embarking on a journey to new highs.
In 2008 the subsequent rally off of the retest produced a lower high that led to an eventual breakdown below the weekly 200MA.
Hence for 2019 this is a crucially important technical dynamic to watch in the weeks and months ahead.
Retest or not, given vast oversold conditions, there are reasons to expect large rallies in 2019 as long as markets can sustain price moves above the weekly 200MA.
Let’s look at some of these reasons.
One of the key reason is the $VIX. In Yearly Candles I highlighted the importance of yearly charts and technical reconnects off of historic extensions. Charts such as $NDX and the $FAANGS were just too extended to the upside and demanded a technical reconnect. These reconnects look much better now but still haven’t fully reconnected yet and hence the potential for a retest of December lows with a new low is a very probable scenario at some point in 2019.
But it is the $VIX specifically that suggests rallies to come and an at least temporary calming of the waters will also be part of the market’s makeup in 2019:
Note in every single year, bull market or bear market, the $VIX will at some point not only reconnect with this yearly 5 EMA (exponential moving average) but it will also dip below it, even during the bear markets in 2001/2002 and 2008/2009 we saw this. As of now in early 2019 the $VIX has yet to reconnect with its 5EMA. So here’s a prediction: $VIX will calm at some point in 2019 and even dip below its 5EMA.
But be clear: The landscape for volatility has changed:
As you can see in the chart above $VIX has broken above multiple wedge patterns. In January 2018 it broke above its 2016/2017 wedge, then based above it during the summer, then broke above its new wedge in October before forming a bull flag. In January now we saw the $VIX retreat back to its bull flag pattern as markets rallied aiming for MA (moving average reconnects). So be clear: Volatility has structurally broken higher and will likely remain elevated for quite some time, indeed as long as it remains in bullish structures it can technically resume its path higher.
For now markets are seeking balance and wanting to reconnect with key moving averages. As of now $SPX remains below its weekly 100 and 50MAs and its daily 50 and 200MAs (moving averages). At some point in 2019 markets will want to reconnect with these moving averages hence they will be key to watch. Note all these moving averages, as well as open gaps above, will pose resistance. As do any broken trend lines. In the chart above I also indicated some reversal fibs that may be of interest.
So be aware there will be a lot of resistance ahead, not only technically, but also supply driven as there are plenty of trapped buyers above who seek to break even. These resistance points will be a key challenge for markets in 2019 and they may prove turning points if a bear market is to unfold.
Only a sustained close above the daily 200MA and the weekly 50MA can give investors comfort that perhaps a major low is in play and markets can head to higher pastures.
Let me crystallize the market’s dynamic challenge for 2019 using one key stock as an example: $AAPL
Last week the stock found support at its 0.50 fib near its weekly 200MA. During the recent bull run the weekly 200MA was key support along with a heavily oversold weekly RSI which then produced rallies into the weekly 50MA before then going on to new highs. Currently that weekly 50MA is at 187. Hence, technically speaking, a move towards that MA reconnect in the months ahead would constitute a technical rally target.
The company just issued a major revenue warning and cited the trade war with China as one of the key reasons for its struggles. How much of the global slowdown has been exacerbated by trade wars I’ll leave for others to debate, but be clear: Companies such as $AAPL would benefit greatly from a positive resolution to the trade war. And it’s not just $AAPL. As Trump economic advisor Kevin Hasset mentioned last week:
“There are a heck of a lot of U.S. companies that have a lot of sales in China that are basically going to be watching their earnings be downgraded … until we get a deal with China,” Hassett said on CNN. “It’s not going to be just Apple.”
And that’s exactly right, hence a positive trade war resolution would likely spark a major rally and could serve as the trigger for a move up to the weekly 50MA on $AAPL for example.
Failure to reach a positive conclusion of course would leave the negative overhang and could very much be the trigger for $SPX to break below its weekly 200MA as outlined earlier. Hence trade wars are key to watch in 2019.
But $AAPL is also symptomatic for larger issues beyond trade wars. Fact is the company’s growth in iPhone sales, its main product line, has stalled. People are upgrading phones in slower intervals as phones have become more expensive and the incremental advances in technology are simply too little to offer a compelling reason to upgrade every year.
What’s that say about the technology cycle in general? The good news for $AAPL and other players may of course be 5G which is just around the corner. As coverage will become available in the next few years it will offer a major reason for people to upgrade. But that’s not happening in 2019 yet.
Fact is slowing growth globally is not only driven by trade wars, slowing growth is structurally driven and hence it is critically important for investors to keep a close eye on larger macro drivers.
In a perhaps good news/bad news sort of way one of the key items to keep an eye on is Industrial Production (IPI):
As similar as charts are to previous market tops IPI has so far not shown a reversal which makes the current market breakdown inconsistent with previous market tops. Yield curves aside, a coming recession would be signaled by a reversal in industrial production. So keep a close eye on December’s data when it comes out. Should we see a break lower it may be an ominous sign. A blip? Or the beginning of something larger? We will need to see and evaluate the evidence as it comes in. As long as data points such as Industrial Production can show a positive trajectory the recent correction may set equity prices on an upward recovery trajectory.
As I said at the outset: Pay close attention and stay fully informed. There are a lot of moving parts here, but they will provide plenty of opportunities for active investors/traders.
In January we will see corporate earnings reports and outlooks which will be closely scrutinized. The Q4 market correction has taken some of the excess out of markets as valuations and market caps have dropped dramatically in some cases and key market signal indicators still show vastly oversold conditions.
Buybacks remain a factor in markets as a source of liquidity, but they were clearly not enough to prevent the break down in markets as redemptions overwhelmed that remaining source of artificial liquidity. The Fed just sent a dovish signal indicating they stand ready to react and adjust their balance sheet reduction schedule and markets rallied hard on this.
In summary my outlook for 2019: Technical considerations suggest a coming reconnect with key moving averages in the weeks and months ahead as well as an at least temporary calming in the $VIX, however a retest of the December low is a distinct possibility at some stage. A sustained break below the weekly 200MA would set markets on the historic path of previous market tops. To the extent that a resolution in trade wars can bring about a resurgence in optimism and delay a global recession markets may find a way to break above the key moving averages setting up for a positive 2019.
A horrific outcome for market participants would be if even a positive resolution to trade wars cannot change the structural business cycle realities and a global recession ensues as evidenced by slowing production, revenues and earnings. And then all of us would be confronted with the scariest unknown monster of all: A coming downturn with central banks never having normalized policy and a lot less ammunition in their coffer compared to previous downturns.
Or as bears would say: Take the blindfold off, it’s beautiful:
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