Earlier this week, I sent you a few excerpts from my weekly Market Update that goes out to Wall Street Examiner Pro Trader subscribers. Unfortunately, I forgot to include the most important chart.
It’s one that I’ve been using for decades… and it’s my go-to for keeping me on the right side of the major trend, and identifying when that trend is changing. It may be the most important chart I construct for just that reason.
For instance, here’s how it performed while calling the recent upleg from the big break in February 2016. Back then many analysts had turned bearish. I had been bearish since before the August 2015 break.
But the indicators on this chart began to tell a different story soon after that February 2016 break. I noted on April 16, 2016 that, “The market signaled a new 2, 3, and 4 year cycle up phase by closing the week above the downtrend channel from last May.” The S&P 500 was then at 2080.
I reiterated that the indicators were still bullish on August 6, 2016. “3-4 year cycle indicators have edged through the long term downtrend lines. This suggests that this cycle is early in an up phase.”
Then on February 26, 2017 I suggested that the market would continue higher until at least 2018. “3-4 year cycle momentum has broken out from an apparent base pattern dating from Q3 2015. The next momentum peak is ideally due at the end of 2017, but prices usually climb for months after momentum peaks. The 3-4 year cycle price high is ideally due no sooner than 2018 and as late as 2019. These patterns suggest that the market is going much higher.”
And indeed it did.
But now, the indicators are changing and the market has told us that the party is over.
We always consider several different time frames because sometimes one cycle is dormant and another is dominant. The 2 year cycle has not been a significant factor in the last few years. But the 3-4 year cycle has been. So we’ll focus on that indicator and an even longer indicator of the long term trend at the top of the chart.
The 3 year cycle oscillator and its accompanying momentum indicator both look “toppy.” They have not rolled over yet. But with the Fed sucking money out of the financial system, that downturn is only a matter of time. Once it happens, it will confirm that we are in a bear market. Given Fed policy, for me, that’s a foregone conclusion.
Note also that the indicator is below the level of the 2014 period despite the market averages being much higher. This is a negative divergence from the market averages. In itself that doesn’t mean much. But when the market turns down from such a pattern it’s usually a sign that bad things are coming our way. Given the long term nature of this indicator, that means a bear market. Bear markets typically last from 18 to 30 months.
Both the 3-4 year cycle momentum indicator and cycle oscillator are on the cusp of turning down. When they do, it would confirm a bear market.
I noted on April 4 that the market was “headed for a test of multiple long term support lines in the 2560 area. I’d allow leeway to the area of the February low around 2533. If that breaks, the next target would be the lower long term trend channel band around 2300.”
Last week we had that test, and the market has staged a vicious rally off that support level, this week.
But unless the rally can stick above 2675, this chart would still look ominous. The lower 3-4 year cycle channel extension comes in at roughly 2550 this week. Several support trendlines are in the 2560-80 area. Remember that the more often support is tested, the weaker it becomes. So don’t be lulled into a false sense of security because the market is bouncing from this level. Any rally that fails to clear 2675 would be a sign of further impending weakness. And even if that’s cleared, the market would face resistance around 2750. That’s the current location of the downtrend line from the January and March peaks. My bet would be that it doesn’t get to that.
The indicator at the top of the chart represents the long term cycle, that is, the big picture secular trend. It’s based on a time frame of 8 years. The momentum and cycle oscillator lines are in huge negative divergences from the S&P index. That signals weakening long term momentum, but not a downturn yet. It is no accident that the indicators topped out when the Fed ended QE in late 2014. With the Fed now draining money from the system, the long term indicators are losing momentum. As the Fed increases those drains in the months ahead, these indicators should turn down. That would be a secular trend sell signal. When that happens, it will be time to be mostly out of stocks, if not out altogether.
The Long Term Cycle Lets Us Know It’s Time to Pare Down Our Portfolio
The current 4 year cycle began from the January-February 2016 low. Assuming that the upleg has ended here, this upleg would be shorter than the last major cycle upleg. That would be another indication that the long term trend is also weakening.
Long term trend indicators have been unusually weak through the 2016-18 upleg. A breakdown from here would suggest a new secular bear market.
Back on February 4 I noted that, “This week’s break created a setup that is consistent with a major top. In January the market broke out above a rising long term channel dating back to a 4 year cycle low in January-February 2016. Then last week it fell back to within that channel, creating a false breakout. Unless quickly resolved to the upside, this could be the end of the line for the bull market.”
That statement refers to the importance of heeding reversals that come from false breakouts. When a market breaks through a key resistance level or trendline and cannot sustain the breakout, it signals exhaustion and likely reversal. I so noted that at the time. So far, that interpretation looks right. All that’s needed for confirmation now is for the market to break the February intraday low of 2533.
We had a good ride from those 2016 lows, but the party ended in January at 2890. It’s time to aggressively pare your portfolio and move to cash and even short positions on the broad market.
One way to profit on the next move down would be to sell short the SPY on a move below 2630 on the S&P 500. Another would be to sell short my favorite short, the RWR, the ETF for REITs on a move below 85.45. I would keep mental stops at 2675 on the SPX and 87.10 on the RWR just in case the market does the unexpected and rallies back toward the highs before turning down for good.