Oftentimes it is difficult to step away from the blinking screens, the headlines, and the flow of data long enough to fully observe the “big picture” environment. Such has certainly been the case lately as the focus on oil and what central bankers may or may not do next has dominated the stock market landscape.
However, when taking an objective look at the weight of the indicator evidence, one can make the argument that stocks are set up to rally in the near-term. There are three key points to this view.
First, there has been an extreme negative reading in our sentiment indicators. While not to the level seen last October, the level of pessimism seen recently is consistent with market bottoms. History shows that when the model in question reaches an extreme, stocks have rallied at a rate of more than 30% per year. And while the model shouldn’t be used as a short-term timing indicator, it does suggest that the table may be set for the bulls to make another run higher.
Next, the firing of the ECB’s “bazooka” (aka the announcement of a sovereign QE program) removes a major overhang on the market in terms of worry and/or uncertainty. Simply put, now that the plan has been officially announced, traders can rest assured that there will be another big batch of freshly minted cash looking for a home each month over the next 19 months. And if traders have learned anything about QE programs over the past 5 years, it is that a great deal of the new money printed by central banks tends to wind up in the U.S. stock and bond market.
Finally, the back-and-forth action seen in the market this year has actually been quite rare. According to Ned Davis Research, the S&P 500 has experienced two 5-day declines within a 10 day span of the first decline. The key here is that such an event has only been seen four other times in history. And the bottom line is that the ensuing price action has tended to be surprisingly bullish.
So to review, the table has been set for the bulls with an oversold condition and extremely negative sentiment, a major source of uncertainty has been lifted, and similar price action in the past has led to some pretty impressive rallies. As such, it might not be a bad idea to give the bulls the benefit of the doubt here – assuming oil doesn’t continue to crash, of course.
Looking ahead to today’s session, global markets were fairly impressed with the ECB’s action and the positive sentiment seems to be helping traders overcome the flash PMI data out of China and Europe. Equities are higher in Europe, China, and Japan, and U.S. stock futures are pointing to a modestly higher open on Wall Street.
Current Market Environment
Perhaps the best thing about the ECB’s announcement yesterday wasn’t the fact that the QE plan was a bit larger than expected, but rather that the uncertainty surrounding the event has now been lifted. The key is that while the ECB is known for dragging its feet and doing more talking than anything else, Super Mario actually delivered on his promise to “do whatever it takes” and did not disappoint the market. So, while the move was widely expected and has likely been priced into the market to a large degree, it appears that Mr. Draghi actually fired the bazooka he has been talking about for the better part of two years. The question, of course is if the plan to buy more than a trillion euros of public and private debt over the next 19 months will be enough to keep the Eurozone out of a recession. Turning to the market itself, our market models have ticked higher and the odds would now seem to favor a move to new highs in the coming weeks. So, unless the bears turn things around in dramatic fashion in the near-term, our models tell us to side with the bulls here.
Looking At The Charts
Yesterday’s joyride to the upside produced a breakout from the wedge pattern that had been in place since the end of December. The good news is that the pattern was resolved to the upside, which, the bulls suggest is a harbinger of good things to come. However, before one uncorks the champagne, there are two issues that remain. The first is the band of resistance seen in the 2075-2090 zone, which could prove challenging. And second, the bears will argue that a fairly large head-and-shoulders top is in the process of being formed. So in the coming days, it will be important for the bulls to break on through to new all-time highs if they want to be taken seriously.
S&P 500 – Daily