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TSP Talk Market Commentary 5/19/2020

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Stocks were excited by a Fed who said this economy isn't likely to turn into a depression, and later some news of very promising results from a coronavirus vaccine currently being tested. The Dow jumped 912-points, and many indices ran toward, or exceeded, last week's or last month's highs, wiping out last week's losses. The S&P 500 closed at 2954, which is just one point off of the April 29th high tick, so it is basically back at the top off its range. Small caps gained nearly 5%, and bonds were sold to get in on the rally in stocks. This action continues to humble the bears, including yours truly.

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Markets are not always rational, but rationality is not generally what motivates buying and selling. It's emotion, hope and fears. Yesterday the market got a double dose of hope with Moderna reporting positive early results from their vaccine trials, and the Fed who reminded us this weekend that they have a bag a tricks that they can continue to use to boost the economy.

When asked where the money was coming from, Powell actually admitted that they are basically pulling the money out of thin air, in almost those words, and they'll worry about that later. Obviously the Fed wouldn't have to keep using those tools if everything was fine, but investors aren't concerning themselves with that right now. They only seemed focused on the backstop the Fed has given that can keep the economy from falling off a cliff despite current conditions.

regarding the rally, once the 200-day EMA was broken on the S&P 500, we were likely seeing "buy to cover" stops being triggering, which magnifies the buying and the upside. If you're not sure what I mean by that, I'll explain from the other side - using a stop when you own a stock.

If you bought IBM for say $107 a share and put in a stop to sell if it goes below $100, your position would be sold once it fell below 100, and that sale exasperates the selling causing the stock to go even lower.

What we saw yesterday would be the opposite but you'd have to understand short selling to get it. If you sold a stock short (bet it would go down) and put in a stop order to buy to cover if it went over a certain price, having that stop hit would exasperates the buying, pushing the price even higher. That's what we saw a little yesterday assuming many used a move above the 200-day EMA as their stop price on the short trades. Got it?

Moving on; it was a day of 3's yesterday with 3 rather amazing stats. The first was the 3% gain in the indices. Not too unusual for 2020, but if you've been following the stock market for any length of time you know that 3% moves are very rare. What made it even more interesting was that it came after an interview with Fed Chairman Jerome Powell who said he's expecting the economy (GDP) to shrink by 30% in the second quarter. There's our second 3. Not in a million years would anyone have anticipated that on January 1, yet the S&P 500 is now only down about 7% for the year. Nobody has seen a GDP like that before, unless you were alive during the Great Depression.

We did see stocks tank in March over the prospects of this kind of economic destruction and the media didn't help as they were complicit in helping take down the economy as much as the virus. While it was happening, we all watched in disbelief as stocks tumbled 30% or more in a matter of weeks.

Since then of course stocks have recovered nicely, but they were stalling at the 200-day EMA, as we might expect in a bear market, but the bulls would not relent and yesterday it seemed to be the bears relenting as the 200-day EMA was broken after the 3rd attempt - our third 3 of the day.

I know I have been pounding the table that this move up near the 200-day EMA would have to be a cap on the bear market rally, and even if it is, it has been hard to watch it move up this high while expecting it to fail. This isn't the only example of a giant rally in a bear market, and the reason I keep bringing it up is because it couldn't set up a more emotional state for investors. Moves like this really excite you, or really demoralize you, deepening on which side of the fence you are on, but they could also get you leaning the wrong way as we saw in May of 2008 when there were 4 attempts at killing the bear market, but they all failed.

Yup, it's this chart again. How may times during the 2000 - 2002 bear market did we see huge rallies up to similar technical levels (200 EMA) give the bulls hope, only to see the rug get pulled out from underneath them shortly after the euphoric rallies?

But this is different, right? This is a virus that can be defeated and the economic shutdown was self-inflicted, right? Yes, but -30% GDP and 20% plus unemployment are real and it may take a while to get back to normal, so new highs for stocks seem like a fairy tale. Yes, the market looks ahead and perhaps a year or more from now we'll get back to seeing much better data, but how much further can stocks go up while businesses are dramatically reducing sales and capacities, increasing costs to deal with the new guidelines, or are just going under, which is very possible for some restaurant chains who rely on volume to stay afloat? Besides restaurants, considered the airlines, casinos, sporting events, theaters, etc. Some may be able to adjust, but not likely all of them.

The reason I keep repeating this is because you can easily forget when we get a day like yesterday - just like it was easy to forget that we were due for a big bear market rally as we got deeper and deeper into the March crash, and it felt like stocks would never rally. They did, and welcome to the flip side.

With this kind of momentum it would probably be unusual, without some kind of news, for this to flip right back over again, but getting a stall for a few days may indicate when the buying frenzy is losing steam.

Now let me throw something out there for the bulls. The S&P 500 has been moving sideways for more than two years so an argument can be made that they've consolidated long enough and not as overvalued as they once were. That's true, but did I mentioned a 30% decline in GDP and 20% - 30% unemployment?

I'm not asking anyone to believe me or to change their outlook. I'm just showing what happened in previous bear markets. Whether it turns out to be what happens this time, I don't know. I just know the emotions at those same periods in 2000 - 2002, and 2008 were likely very similar to the ones we see out there today. Bear market rallies are very emotional.

The S&P 500 (C-fund) gapped up Monday, inching just above the April 29th high. This is the third test in this area and we could be getting ready for a breakout, or it could just be hitting the top of the range and ready for another dip. This 2950 area has been a key level going all the way to 2018. with 2600 being the lower end of a long-term core range. There are now 3 major open gaps (red rectangles) on this chart and we'll have to see how long the bears will, or can, allow them to remain open.

The DWCPF (S-fund) ran up to the top of its range, looks to be on the verge of a breakout, but it also has that 200-day EMA to deal with if it does.

The Dow Transportation Index was in a clear bearish looking head and shoulder pattern, and had broken down last week. Yesterday's rally pushed it all the way back up to the 50-day EMA and we are now seeing what we call a "head test."

These are old charts that I have posted before that show a couple of ways that head and shoulders patterns play out. The head test is less common, but as of today, it looks to be the way that it is going on the Transports.

The BND / F-fund took a hit from the rally in stocks as people sold bonds to get in on the rally. Plus the encouraging boost the Fed is willing to give the economy helped push yields higher, which is bad news for bonds. The 20-day EMA was tested again and held, but it is back within that bull flag after a failed breakout.

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Thanks for reading. We'll see you back there tomorrow.

Tom Crowley

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