This past week saw the markets rebound off their lows which has brought the "bulls" rushing back claiming the correction is over. However, is that really the case? As I questioned earlier this week:
"As you can see, the markets did retest the late August lows, and when combined with the very oversold conditions, led to a frantic "short covering" rally back to previous resistance. It is worth noting that the recent market action is very similar to that of the August decline and initial rebound as well.
Of course, the question that must be answered is whether we have seen the end of the current correction or is this just another "reflexive rally" that will fail?"
"While the 'seasonally strong' period of the year could foster a further rally in the market, it is highly likely that it will ultimately fail. As shown, since the turn of the century there have only been two previous times when the market traded in oversold territory combined with all three major 'sell' signals triggered. Both of these periods marked a much more severe bear market cycle."
"Given the late stage of the current market cycle, the issue of rising global economic weakness and deflationary pressures and deteriorating earnings, many of the "bullish" arguments have been broken."
However, as always, it is important to look at the current market environment for opposing points of view to reduce the potential of "confirmation bias." This weekend's reading list provides a broad look at the current market environment from both the "bullish" and "bearish" perspective. Unfortunately, we will only know "who's right" after the fact.
But here is the rub. If you choose the "bearish" view and are wrong, you only miss out on some of the rather limited potential upside from current levels. If you choose the "bullish"view and are wrong, you suffer a real destruction of investment capital.
This is a point that is rarely discussed, but is a harsh reality. As I stated last week:
"Hoping to get back to even" has never been a successful investment strategy.
THE LIST
1) A Major Headwind For Stocks by Jesse Felder via The Felder Report
“And if profit margins reverting to their long-term mean leads to falling earnings growth, is it any wonder that major peaks in profit margins don't just foreshadow major stock market peaks but economic peaks, as well? The chart below comes from Barclays). It demonstrates that only in 1985 did the economy avoid entering recession after a 60 basis point decline in profit margins, the degree of decline we have just witnessed.
Clearly, record-high profit margins have been a significant driver of both the economy and the stock market over the past few years. But this, 'most mean-reverting series in finance,' looks to be rolling over and now this powerful tailwind could is shifting into a headwind."
2) A Bullish Pause Or A Bear Market by Tom Petruno via LA Times
“The forces weighing on stocks, including global economic fears, weak corporate earnings and expectations of rising U.S. interest rates, haven't diminished. That makes it a good time for a financial reality check to better prepare yourself for whatever markets bring.”
3) Disregard Dow Theory At Your Own Peril by Jack Schannep via MarketWatch
“So where do we stand now? Thus far, the correction lows on Aug. 25 were some 12% to 13% below all-time highs, from which there was a three-week bounce into September. That being a qualifying secondary reaction, it set up the possibility of a reversal to a Dow Theory buy signal. Later in September was a setback, which successfully tested and held above the August lows, which is encouraging, and now what is needed is for the Transports to join the Industrials in surpassing their bounce high of 8,215.44. For the Original Dow Theory, the interpretation to get a buy signal is really just that simple. The odds of the sell signal being profitable are quite favorable. There have been only seven of 24 such signals since 1953 that did not go into a bear market that year, making it hard to ignore any Original Dow Theory signal.”
4) Bull or Bear? Market At A Crossroad by Michael Ashbaugh via MarketWatch
"And the S&P 500 has staged the U.S. markets' headline technical move.
To start, the index bottomed last week at 1,871, just above major support at the August low. It's subsequently knifed to major resistance, topping Monday just four points lower.
Price action within the range is technically bearish, though the S&P's response to the range top is worth tracking. The S&P's 50-day moving average (1,998) is descending to match resistance."
Read Also: Margin Pressures = Subdued L-T Returns by Cam Hui
5) Despite The Rally, Charts Favor The Bears by Michael Kahn via Barrons
"Technically, Friday's drop and recovery following the weak September jobs report was quite bullish. Unfortunately, there are still too many negatives out there to rely on this one indication, and that means it is far too early to change teams from bear to bull.
To be sure, the big bearish signal of a drop below the August low has still not happened. That leaves the market in somewhat of a funk but with a downside bias.
In previous columns I suggested that the Standard & Poor's 500 was in a giant head-and-shoulders topping pattern spanning back nearly two years. The neckline, or support line, slopes gently higher but for simplicity let's just say that it comes in now at 1870 – roughly the same level as the August low."