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Broad benchmarks posted their biggest declines since October 2019 on Monday, Jan. 27, with the S&P 500 dropping 1.6% while the Nasdaq 100 fell 2.1%. Both indices hit all-time highs just last week, but many investors now wonder if the stock market is starting to top out. It seems like an odd question in the middle of a roaring bull market, but outsized gains in recent months may be unsustainable, setting the stage for at least a multi-month correction.
While it may take years for the market to enter a secular bear market, there are good reasons to consider taking profits and heading for the sidelines at this time. Technically speaking, the advance that started in October has lifted relative strength readings to extremely overbought levels that have triggered past downturns. In addition, both the S&P 500 and Nasdaq 100 have reversed at trendline resistance going back five or more years.
Investors should also worry about political headwinds that could stop the bull market dead in its tracks. While the coronavirus outbreak sits at the top of this week’s wall of worry, other potential roadblocks are building as well. For starters, the virus has drawn attention away from the impeachment trial at the same time that John Bolton revelations increase risk that President Trump will be removed from office. It isn’t likely that a “President Pence” will support the stock market as forcefully as the current administration.
The rise of Bernie Sanders in the polls also must be viewed as market-negative because he’s a lifetime critic of American corporations and their business practices. The Iowa caucus will be held on Monday Feb. 3, and a Sanders victory would give him lots of momentum heading into New Hampshire and other key states. That’s certain to upset the stock market because the smart money currently believes that Trump will easily win a second term.
An earnings slump could also drop major indices in coming weeks. On CNBC last week, legendary bull Art Hogan insisted that weak fourth quarter earnings pose a greater threat than the coronavirus outbreak, stating, “We’re going to see the losers lose a whole lot more than we’ve seen in a while,” while expecting a 3% to 5% correction. That may be overly optimistic because Hogan’s Natl Holdings Corporation manages more than $1 billion dollars, and he needs to protect his interests.
SPY Long-Term Chart (2008 – 2020)
The SPDR S&P ETF Trust (SPY) and the S&P 500 completed a round trip into the 2007 high in 2013 and broke out, entering one of the strongest bull advances in market history. Price action between 2012 and 2014 hugged a rising trendline, month after month. It turned away from the trendline during the 2015 through 2016 correction and returned for the first time in four years in January 2018. The level triggered an immediate reversal and decline that ended in December at an eight-month low.
The uptrend through 2019 accelerated in the fourth quarter, reaching the trendline for the first time in two years last week, at the same time the coronavirus outbreak was picking up steam. This strange convergence between mathematics and biology has triggered another reversal, but we don’t know if it will have the same effect it did in 2018 due to the slow creep higher between 2012 and 2014.
Even so, the reversal highlights overbought technical readings, confirmed by the monthly stochastics oscillator reaching an extreme level that has triggered at least seven sell signals in the past 13 years. At a minimum, these bearish technical elements confirm the need for caution, warning shareholders all across the stock market not to throw away outsized gains posted since the start of 2019 by sticking around too long.
The Bottom Line
A wave of headwinds raises the odds that broad benchmarks will turn lower in intermediate corrections that give up a good portion of gains posted since October 2019.
Disclosure: The author held no index funds at the time of publication.
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