The terms I tossed into today’s headline are good examples of what I’m talking about. If you’re an active investor, and you’ve invested time and energy into studying the markets in much detail, you’ve certainly across these terms before, because they are actually very descriptive of a couple of a very specific market conditions, each of which carry their own implications, opportunities and risks.
Since February of this year, the market revisited 52-week lows around the 2,600 level for the S&P 500 on multiple occasions, only to bounce and move higher again. The market’s muted upside for the year created a limited range from those pivot lows to the next resistance point, and that is what defines consolidation. Consolidation ranges are useful within longer trends, because they provide the market with time to reevaluate the strength and health of that trend before taking the next step. If you’re paying attention to those levels, and to the distance between the top and bottom end of that range, you can identify near-term trading opportunities.
Breaks out of consolidation ranges can be interpreted in pretty straightforward terms. Breaks above the top end of a consolidation are almost always a bullish indication, while breaks below the lower end of the consolidation are almost always bearish. Consolidation ranges also tend to become more useful at the extreme end of a long-term trend; at the end of the last bear market in 2009, for example, it was a break above a consolidation range from late 2008 until the end of the first quarter of that year that marked the beginning of our latest bull market. In fact, that bullish break out of a consolidation range helps to provide the context that I want to apply to the market’s current conditions.
This chart covers the last three years of market activity, because I want to try to put the market’s movement since the end of September in the most complete context possible. The horizontal green line on the chart shows the support level the market had been using repeatedly throughout the year to stabilize and look for new reasons to move higher. You may recall that I’ve referred to using 2,600 on the SPX as an important signal level, because those support bounces were pretty obvious to see. The last few days have finally seen the market break below that level – and that is where the term capitulation starts to come into play.
A break below a consolidation range isn’t automatically considered capitulation, but it certainly can be, and in this case I think it clearly is. The reason I believe that is both technical and emotional. Technically speaking, the fact that the market has followed the initial drop below the 2,600 level with multiple days of continued downward pressure is significant. It’s the kind of follow-through that most technical traders usually look for as confirmation a breakout (or breakdown) has actually occurred.
The emotional reasons I’m calling this capitulation center around the way market commentary and focus seems to be shifting. Instead of trying to look for positives to keep things stabilized, or moving higher, I’m starting to see a lot more conversation, analysis and speculation about how bad things could actually get. The market is starting to look for reasons to stay bearish, and in my experience is something that can often create a self-fulfilling prophecy; investors are afraid the market is going to keep going down, so they start selling more and more, which means that the market has to keep going down.
The Fed yesterday raised interest rates for the fourth time this year, as expected; but they also seemed to try to use a more accommodative tone about the economy, suggesting that rate hikes in 2019 could be fewer depending on new economic data at that time. The market’s reaction was to shrug any hint of silver lining in the news and keep selling. The prospect of a government shutdown has only added to the angst this week, and this morning news broke that the U.S. and the U.K. are combining forces to accuse and charge China of waging a sustained campaign of focused cyber theft of commercial intellectual property. The monster looks like it could be starting to consume itself.
The market still isn’t in bear market territory; as of this writing it is still only down about 16% from its October high point. And there are a few technical levels ahead that could act as new support based on previous pivots if the market can find some bullish headwinds; 2,400 isn’t far away, and that looks like it could provide a solid support point. Considering some of the emotional, buzz-worthy news items that are hitting the markets right now, however, it looks like we might not see another viable level for any kind of consolidation or stabilization until somewhere between 2,000 and 2,100. That puts a real bear market in clear view right now.
What does that mean for taking on new positions? I’m still not afraid to initiate a new trade, even under these conditions, if I think the value proposition in the stock I’m working with justifies it; however I am going to keep my position sizing rules very conservative. The same right I’ve reserved for several months now, to suspend new trades at any point, or to skip on a trade during any given week remains in force. It’s smarter right now to be cautious, and to wait for a great opportunity to come your way than it is to try to keep making new trades.
I hope everybody has a wonderful Christmas next week, and that you are enjoying this holiday season! There will be no post next Tuesday since that is Christmas day.