The 290 gap is filled. Where are equities headed next?

작년

It has been a while since I talked about the equities market. In one of my earlier posts, which was almost 2 months ago, I said that the equities market is technically oversold. I mentioned a few targets that might get hit when a reversal does come. One of them is the gap at 290 for SPY.

SPY daily chart. 290 gap marked with yellow circle

As you can see from the chart above, the gap (marked in yellow circle) at the 290 level on the SPY chart has been filled. Of course, my previous analysis was way off in terms of timing and the equities market got even lower before it rebounded to the 290 level. With all these now in our rear mirror, the big question will be where is the equities market heading next?


Bullish scenario

My key argument for a bullish scenario is two-folds. First, in terms of market sentiments, the fear & greed index for the stock market is largely in a balanced state. There is neither too much fear nor too much greed.

Fear & Greed Index

Source

Equities market thrives under such "Goldilocks" kind of situation where there is a balance. The equities market is by itself a rather risk-balanced market. An investor can go defensive or aggressive just by allocating his/her funds into different sectors. So when there is neither too much fear nor greed, the market is stable and inches up gradually.

The other key factor for a bullish scenario is obviously the Fed and US government interventions. Yes, one may argue that when QE started in November 2008, the market rallied but subsequently dipped to a lower low.

SPX chart during 2008 global financial crisis

However, I must point out that the magnitude of the Fed's intervention this time is way larger than what they first did in November 2008. There are trillions of USD poured into the alphabet soup bailout programs, like how George Gammon would put it. So things are likely different as compared to the 2008 crisis. Unless we see another black swan (e.g. 2nd wave of infection), the bullish case will be that the equities market has hit its low on 23 March and we probably won't see a lower low.

Technical side

On the technical side of things, we see that this recent run-up is coupled with strength in the RSI and a decrease in volatility.

SPX daily chart

The RSI has not hit overbought levels despite the rally. In fact, it has not even hit overbought at the lower 4-hour time-frame.

SPX 4H chart

This symbolizes strength and that this rally is not driven by FOMO.

In terms of RSI + price movement profile, this crash is more akin to the Aug 1987 crash. Charts below show that we have similar percentage price draw-down and the RSI went to oversold in the weekly time-frame but not the monthly time-frame.

35% price draw-down with RSI hitting oversold on weekly time-frame in Aug 1987

RSI did not get to oversold level on the monthly time-frame in Aug 1987

35% price draw-down with RSI hitting oversold on weekly time-frame in Mar 2020

Similar to 1987, the monthly RSI did not get to oversold level in Mar 2020 crash

If history is of any guide and this crash behaves more like the 1987 crash, then it is unlikely to see a lower low. Whether the price will just go up from here is an unknown, however, an immediate crash without fresh catalyst seems unlikely in this bullish scenario.


Bearish scenario

My bearish scenario is more qualitative and speculative. As I have discussed in the bullish scenario, I do not see any immediate weakness or indicator for the equities market to turn bearish. However, fundamentally, we all know that there are serious problems in the horizons.

Yes, we have all these bailout money for now, but how sustainable is it and are these money getting to the hands of the right groups of people? Or are we repeating 2008 all over again. I saw a tweet today that Tron got a $2 million funding from the Paycheck Protection Program and Chico Crypto also made a video about this. If that is true, I seriously doubt the money are going to the right party. First, is Tron a US company? Second, with Tron being able to splurge on acquisitions like BitTorrent and Steemit, why will they need such funding?

Another possible bearish path that we might take is that when the lockdown measures are eased and people start to go back to work, reality might truly set in. Those who think that things will get back to normal after the economies open up might be surprised to find that it is not the case.

First of all, there will bound to be some jobs that will be lost permanently and unemployment rate will remain high. Morale will take a hit and same for market sentiments. Next, general consumption of goods and services may remain low. So while companies can explain their poor quarterly results now with COVID-19, they may not be able to get away so easily in the coming quarters if sale remains weak.

This is a likely scenario if we look at what is happening in China. China had a long weekend because of labour day celebration during the past weekend. Looking at traffic data in Shanghai from Tom Tom, we can clearly see that the activity level was much lower than the average in 2019.

Shanghai Traffic data

Source

This is the same for Beijing and Shenzhen as well,

Beijing Traffic data

Shenzhen Traffic data

This shows the lasting effect that this pandemic can bring to society. People will continue with their preference to stay at home even after the lockdown is lifted. This is likely to sustain for a period of time. With less people heading out during the weekends, businesses like retails, restaurants and travel will continue to do poorly. When this reality sets in, the equities market might be in for another leg down.


Conclusion

In the near-term, the risk for a sudden crash seems to be low. However, we are certainly not out of the woods yet because fundamentally, the outlook remains weak. In addition, the equities market remains overpriced by many metrics as I have previously discussed and it got even worse due to this rally.

Hence, personally, I am taking a cautious approach in trading the equities market now. I believe, there will be buying strength in the near-term but things can change quite quickly when the fundamental factors come into play.

With all these being said, I think that the chances of getting a lower low is probably less than 50%. We might see another round of sell-off, but I seriously doubt we will go lower than what we saw in Mar 2020. On the technical side of things, I think SPY is going to test the 300 level and fill the other gap at that range rather soon. Coincidentally, the 300 level is also the 100d and 200d SMA levels. As I mentioned before, prices are typically drawn towards such confluence of important levels like a magnet.

SPY daily chart. Gap at 300 level market in yellow circle

Again, I am just sharing my thought process and please do not take it as financial advice. Due diligence and research are still required for your own investment 😄. I am planning to write an article on how all these money printing is going to seriously inflate the USD and how it might affect your investments. In that article, I will also flip your perspective a little to measure your investments in terms of gold.


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@culgin as per my suggestion currently all the equity will face the meltdown. But this is good time for investment for the big ones.