- New Science in old markets -

Equities – this may be a bigger moment than we thought

We have been writing that equity markets are vulnerable to a drop, since the November 15th edition.  This view was based on a series of daily-scale top extensions that appeared in US and far-East equity markets after the Trump election victory which apparently heralded the era of a new Pericles. The market's rally was puzzling to many, as Trump had been so comprehensively trashed by opinion writers in Europe and the US it but makes complete sense if you consider how the markets would have behaved had Mrs Clinton won. Just as both candidates were described as the two most hated in history, so it is instructive to consider another negative - which was the less disappointing victor? Obviously it was Trump, hence the sharp rally.

That is enough for a short squeeze in a world full of early bears but is a thin reason for a sustained rise and we are now seeing weekly-scale top extensions in the US and Chinese equity markets. This changes the order in which we expect things to happen. We thought there would be a dip of a few weeks in the US which would then lead to another 'buy' for yet another rally on the way to the eventual high point - maybe 'one more leg up' to go before the end of the bull market.

This doesn't seem likely now, as weekly-scale signals have a shelf life of 3-4 months and that could easily spell the start of a bear market from here. So far there have only been signals in some sectors, not the any of the big three indices but these sectors include airlines and general transport, also banks and other finance companies. These top extensions are not yet widespread but there may be enough 'rotation' within the market as a whole to spell the end of this whole upmove. Some tech sectors (which didn't generate signals) have already dropped a few percentage points in the last week, so it looks as though this could be the beginning of the end. If short, stay short and lengthen the likely duration of these positions. The story in charts, starting with the daily signals:

sp400-500-top-exts

Next the markets turned down and we saw some weekly top extensions, firstly two weeks ago and again last week:

us-fin-and-tran-wkly-top-exts

There have also been similar signals in a Chinese index that we follow and the US ten-year treasury note yield:

10-yr-yield-china-wkly-top-exts

 

We need to make our customary warning about top extensions. These are strong signals but they do not mean that we expect that price will fall from here. The usual pattern is for a bull move to end with top extensions and the  for some kind of 'top' to form. Only after that is there likely to be any serious price weakness. 'Spike' tops are possible of course and the present set of circumstances makes one a bit more likely here, which is why we suggest staying short - a drop back to around 2100 in the S&P without much in the way of bounces is quite possible, due to the nature of the most recent run-up. We characterise the November move up from that level to the recent highs just above 2200 as being a 'squeeze' mainly fuelled by early bears covering.
More soon as the story unfolds.

All signals generated by software supplied by our friends at Parallax Financial Research www.pfr.com