March Outlook: Still Bullish – Correction Brings Market & Valuations Back Inline By: Jeffrey A. Hirsch & Christopher Mistal | February 22, 2018 | Email | Print

The return of volatility over the past four weeks has been quite a reality check for the market and its participants. However, it has not shaken our resolve and our bullish outlook for 2018. Economic data and forecast remain robust, but improving economic conditions are a double-edged sword for the market. 

 

Historically stocks tend to struggle in rising rate environments, but these levels are still well below historical averages for the 10-Year Treasury yield and below the lower end for the benchmark yield of around 4% prior to 2008. The uptick in growth, inflation, wages and corporate profits stoked fears of an accelerated run up in interest rates, which spooked traders and investors and heralded in a return of volatility that began at the end of January.

 

This influx of real volatility – larger daily and intraday market index price swings – caused a run on the latest Wall Street invention: low volatility derivatives, especially inverse VIX Exchange-Traded Products (ETPs). The long-awaited 10.2% correction that appears to have found support at the February 8 close – at least for now – has brought valuations, stock prices and the overbought conditions back in line to less overextended levels.

 

It’s been 2 full years since the last 10% correction, so make no mistake; this was a warning shot that market volatility has returned and the days of super easy gains being long and strong stocks and the broad market and short the VIX are likely over. This makes the historical time-tested seasonal trading trends and pattern for frequency and magnitude detailed in the Stock Trader’s Almanac for 51 years, continually updated and verified in this newsletter, even more imperative to include in your trading and investing arsenal. 

 

The fact that this correction happened in classic fashion in February, the weak link in the Best Six Months, where big January gains often correct or consolidate, lends support to the efficacy of and return of market seasonality. This looks like a textbook setup for midterm Worst Six Months market soft patch and perhaps further correction during the May-October period. 

 

March remains strong in midterm years, but April, May and June are weaker in midterm years, so we suspect the rally to resume higher toward the January highs in March. Volatility is likely to continue, but we don’t expect another meaningful pullback until the end of the Best Six Months. Midterm election campaign machinations and political rhetoric are likely to heat up already heightened tensions in Washington, fanning any market jitters from the new Fed, higher rates and market gyrations. 

 

Bullish sentiment has come down considerably and technically the market is going through a constructive consolidation. The market is attempting to reclaim the middle of the uptrend channel that has been in place since mid-November 2016 just after the post-election rally consolidated. After blowing through the upper-end in mid-January, the market pendulum swung quickly through the lower-end during the nine-trading-day 10.2% S&P 500 correction. Then it bounced firmly off the red 200-day moving average intraday the next day. Last week’s rebound delivered a positive crossover in our MACD indicator.

 

 

As the market hit its low on February 8 we noticed an encouraging technical reading. The market may have formed a “W” 1-2-3 swing bottom with the February 6 intraday low. Clearing the middle of the “W” high at point 2 (the February 7 intraday high) and closing above it (which it did on February 15 and 16) would be encouraging. In addition, the VIX was significantly lower at the February 8 low than it was at the February 6 low. 

 

 

This week’s trading action brings us back below that crucial intraday high level reached on Wednesday, February 7. This is also right at the green dotted monthly pivot point support level and the pink 50-day moving average. Keep a close eye on these important technical levels. And also be on the lookout for typical end-of-February weakness.

 

 

Over the most recent 22-year time span the end of February has been prone to weakness. The bulk of the weakness appears to land on the last trading day of the month or the penultimate trading day, but it can begin as early as the fourth to last trading day. This weakness has been evident in Februarys with a gain or a loss. Perhaps it is the winding down of earnings season that triggers weakness in some years. This weakness can be seen graphically on page 20 of the Stock Trader’s Almanac 2018 or in our post last month “February’s performance generally improves in midterm years,” and in the table below.

 

 

Finally, while midterm March is historically strong, like Julius Caeser: beware The Ides of March as well as the week after March Triple Witching and the end Q1. The market tends to come into March strong, but then after mid-month is prone to weakness and big end-of-Q1 hits.

 

 

 

DJIA peaked on January 26 (1) when it closed it 26616.71. Although it never went any higher, January 2018 still closed with a 5.8% DJIA gain and the best single-month point gain on record. This was just the fifth month to ever gain 1000 or more points. However, any cheers quickly faded and fear took over in early February as DJIA and the rest of the market rapidly sank into a correction. DJIA did take out its December Closing low on February 8, but quickly rebounded the following day.

 

The nosedive from record highs turned both the faster and slower moving MACD indicators applied to DJIA negative. As a result of recent strength the faster moving, MACD “Buy” indicator (2) turned positive on Friday, February 16. DJIA’s slower moving indicator is currently trending in a positive direction, but has yet to issue a bullish crossover confirmation. Today’s gains moved it closer, but more is still needed.

 

 

After advancing in nine of ten weeks, DJIA’s streak of success ended with a thud and the first Down Friday/Down Monday (DF/DM) of 2018. Monday February 5th’s DJIA decline (3) was the worst daily point loss ever, but it was only a 4.6% drop. DJIA’s worst ever single day was October 19, 1987 when it plunged 22.6%. Like most other DF/DM’s in recent history, this occurrence did precede further declines as DJIA went on to decline another 1000-plus points on Thursday of the same week. S&P 500 (4) and NASDAQ (5) also suffered similar magnitude declines in the week as DJIA.

 

NYSE Weekly Advancers and Decliners data also plummeted (6). Weekly Advancers were outnumbered by Weekly Decliners by nearly ten to one. The last time this level was neared was in July 2011 while it was last exceeded in May of 2010.

 

New Highs evaporated and New Lows exploded (7) during the two week correction as expected. Last week’s solid gains ended that trend, but a full recovery is not likely until the major indexes return to and exceed their respective previous all-time highs.

 

A tight labor market, fears that the Fed may be moving too slowly to tighten monetary policy and swelling Federal deficits have finally started to put pressure on Treasury bond yields. The most notable increase occurred with 10-year yields while 30-year yields have only risen modestly. At 3.14% last week (8), 30-year yields are just below their peak in December 2016 of 3.16%.