Is All the Good News Priced In?

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This article is not a recommendation and is intended for educational purposes only.

Stocks are in the midst of their third losing week in four, volatility’s building and interest rates are rising. Some potentially significant chart patterns have also emerged following some important news events. That makes it a good time to take a step back and consider the bigger picture.

First, how has price performance changed? Let’s say the current bull move began with when the S&P 500 breaking out to new highs in November 2016.  Only three instances during the run did the index have three negative weeks in a rolling four-week period:  December 2016-January 2017, late March-April and July-August. But each of those were pretty minor in the big scheme of things, with total drawdowns of less than 3 percent at a time. That makes the sheer magnitude of the recent declines, almost 4 percent at the start of February and 5 percent the subsequent week, look huge. A different climate? Maybe.

Next, the charts. Selling intensified on February 5 after the S&P 500 dove below its 50-day moving average. The index briefly tried to claw back above that level, only to close back below it yesterday. Some trend watchers may view that as a potential change in direction.

Yesterday also featured a higher high and a lower low than the previous session — an outside day, for you candlestick watchers. It’s usually considered a reversal pattern, bullish following a drop but the opposite after a rally. Given that it came on the heels of a sharp bounce the previous week, this time it might look more bearish.

Those are some technicals. How about the fundamentals?

“My equity-risk premium model shows stocks are expensive based on their earnings — especially when you consider this rising yield environment,” said Eugenio A. Pérez, CFA, data scientist at TradeStation Technologies. He added that even at the market’s low on February 8, valuations only scored a 9 out of a possible 100. “We cannot say it’s bearish per se, but it’s definitely not bullish.”

Fausto Pugliese, a fast-money day trader, is about as different from Pérez as they come. But he agrees with the number-crunching quant when it comes to the broader market. Pugliese correctly anticipated the first support level when the bears sharpened their claws early this month. His next level would represent a deeper drop to areas last seen in May 2017.

Next, let’s think about the news cycle. It’s been positive because economic reports like consumer confidence and hiring are near long-term highs, while executives see tax cuts fattening profits. But, all those catalysts have been known and may be “priced in.”

So, what’s next? Here are a few key items to watch:

  • February 27: Durable goods orders and consumer confidence
  • February 28: Revised fourth-quarter gross domestic product
  • March 1: The Institute for Supply Management’s manufacturing index
  • After those, big employment numbers follow the next week. (ADP and Labor Department payrolls.)

Remember that policymakers at the Federal Reserve have said they want to “take the punch bowl away” by raising interest rates. Will traders begin to view the glass as half empty as the central bank’s next meeting approaches on March 21? Will “good” economic numbers be “bad” because they remind people interest rates are going higher? Furthermore, earnings season is over until mid-April. That may, in effect, starve the bulls of good news until April and keep attention focused on higher interest rates for the next 1-2 months.

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