Our short-term sentiment indicator is in the peaking stage signaling that the conditions that prompted our March 24th broad market rally forecast are coming to an end.
This is not to say that the equity markets will necessarily decline, just that the short-term conditions for a rally have mostly been exhausted.
The reward / risk ratio is now no longer supportive of a strong short-term broad market rally, so we are removing our recommendation. The following 30-minute interval chart shows the timing of our March buy signal as well as today’s signal for the NDX.
Major indices around the world have had some of their best period performances since March 24th.
However, when we made the call at the end of March, there was tremendous volatility to say the least. Many experts were at that time calling for a 1929 type equity market crash and possibly over a million deaths in the US from Covid-19. Our positive call was extremely out-of-consensus to say the least. And, the timing, which was made essentially at the low, could not have been better.
Looking forward, equity market conditions look more hazy.
Our expected broad equity market rally has already occurred, moving further and faster than most every market observer thought possible when we made our March call. Markets have also adjusted expectations around expected Covid-19 deaths, economic collapse, and societal implosion.
On a very practical level we see choppy markets ahead due to a variety of risk factors that we expect to take the spotlight over the coming months, lasting until at least early autumn. Such factors should keep newsflow, on balance, negative.
The following should be taken into any scenario:
- Return of Covid-19 in the Fall — the consensus currently believes that the coronavirus could produce considerable chaos again when the northern hemisphere begins its flu season, or thereabouts. This implies markets could be on hold until then, or perhaps until around October – November,
- US Presidential Election — the 2020 election is scheduled to take place November 3rd. It is shaping up to be one of the more contentious in history. Equity markets, again, could wait to see a resolution before making another major up move,
- US vs China Disputes — with the US presidential election hitting general election mode there is bound to be considerable discussion over US / China trade as well as China’s role in the Covid-19 pandemic. This type of rhetoric will likely become sharper into the fall running up to election day and should keep markets nervous,
- Return to Economic Activity — this process has begun in a variety of locations and many credit the most recent equity market rally to expectations surrounding a re-opening of the economy. Markets rightly expressed relief that re-openings started, but the reality is bound to be choppy with considerable setbacks and political fights between those demanding re-opening and those demanding public health safety. In short, the return will likely be choppier than most had expected. We do not expect this cloud to lift until the autumn when there is some basic visibility around a Covid-19 return,
- Return to Schools — when schools are closed it has a tremendous impact on working families, so the return of students to school is a fundamental aspect of the economic recovery. Only in the fall will we see how schools respond to an unexpected case of Covid-19 — will they temporarily send a class or the entire school home, or could they shut the school for a longer period? Or, would a contained local outbreak produce a statewide school shutdown, and for how long? We will likely know for sure only in the September to November time frame,
- Lawsuits — we should expect an onslaught of lawsuits related to Covid-19. What should be covered by insurance policies? To what extent are employers liable if an employee becomes hospitalized after coming down with Covid-19? Can countries be held responsible for the pandemic? We expect such lawsuits to be major topics of discussion over the coming months,
- Summer Seasonality — summer is known for being a dull period in the market. This observation is not original or new, actually it is a well known phenomenon often referred to as ‘Sell in May and Go Away’. And, then there is always traders’ superstition of being wary of October. Seasonal impact on price, though not scientific, will just be another headwind over the next 4 to 6 months.
Individually, these factors do not seem so foreboding. But together, they should produce enough pressure to keep the market from continuing its current rapid bull run.
Put in other terms, the relief rally that we were expecting as the markets realized the impact of the coronavirus would not be as bad as they had forecast seems to have already occured. The newsflow looking forward over the coming months will likely skew negative as we expect the aforementioned topics will prevail.
The ‘world did not end’ sentiment boost should counterbalance the negative newsflow going forward, but recall that the NDX reached within 4% of its all-time high this week. In other words, the positive sentiment reversal that we forecast at the end of March has mostly been incorporated into price.
Additionally, most of the risk factors that we highlighted are expected to peak around the same time, from early September (around when schools begin) to around early November (2020 election-day). From our experience, when there is such a timing cluster, markets tend to drift or decline going into it, not always but usually.
The rapid ~8 week market rally seems to be coming to an end. But is it time to sell?
It is advisable to choose a stop level or even something as simple as a moving average or some other basic indicator that can work as a trigger to get out of your long positions. Assuming you got in on March 24th, you should be sitting on plenty of profit. With the market still strong, you might just want to wait before getting out. Such a strategy is acceptable given the positive market trend.
Overall, we no longer see a clear positive buy signal for the current market while seeing multiple risk factors that we believe coincide around the October time frame.
Our current strategy is to start transitioning from a speculative long portfolio established in late March to a more neutral portfolio while looking towards the September to November time frame as the next key entry point.
As always, please refer to our disclaimer on this site and please discuss any investment ideas with your investment advisor prior to making any investment decisions.