What makes this market so challenging is the contrast between the historical strength of the 4th quarter of the 3rd year of a Presidential Cycle, and the extremely bearish macroeconomic reality of the present day. If you believe in the strength of the seasonal tendencies and allocate 100% to the stock funds, your potential downside risk is very significant if this 4th quarter bucks the historical norm. If you get sucked into all of the very bad macroeconomic news and allocate 100% G fund, you will not participate in a potential Q4 rally. This is where Technical Analysis really shines! TA does not tell us what will happen in the future but it does give us guidelines to know, as early as possible, which way the market has decided to go.
We posted the chart below in the 11 October Alert Analysis. At that time, we talked about this being a low risk entry into the C fund. In the 2 Newsletters prior to the 11 October Alert Analysis, we also explained the low risk entry but, wanted a buy trigger to make a change in the Grow Model Portfolio.
During the first 2 weeks of October, the C fund was consolidating along its upward sloping long-term trend line. It was also just above its 200DMA line, and had completed an A-B-C-D consolidation. This was a perfect place for stocks to find support and rally into the end of the year. What made this reallocation low risk was that price was right on the confluence of support levels. Failure of that support was a clear sell trigger. That gave a quantifiable and very small downside risk for a big upside potential gain.
Now let's fast forward to what happened since that Alert Analysis. The S&P rallied and consolidated above its 20DMA until Wednesday of this week. On Thursday, sellers came back into the market and buyers moved out, as we can see in the red line of the ADX indicator. CCI and RSI both rolled over although MACD was still positive.
The rally failed and price has undercut its long-term trendline and its 200DMA line as of the close on Friday. If you followed the 11 October Alert and the 20 October Alert, you took the small loss that was identified as a very real possibility.
The 4200 level was identified as the final line in the sand because it was just below the other layers of critical support and was resistance from the February top until the gap up in late May. The 4200-4300 level has been an important support/resistance zone from the August 2022 high to present. A close below 4200 implies that the market is on its way much lower.
Technical Analysis, Elliott Waves, and Fibonacci retracement levels are not a crystal ball. They cannot tell us the future of price movement. They give us likely probabilities and clear rules to identify when the primary probability becomes invalidated. This is how we manage downside risk. It does not eliminate all risk but it does help us to avoid massive downside losses while setting us up to take advantage of potential upside gains.
From an Elliott Wave perspective, Friday's close was a serious problem. We talked about this in detail in last weekend's Newsletter. A close below 4200 invalidates my primary Elliott Wave count and the alternate count becomes primary. Below is a chart of the alternate count from last weekend's Newsletter. If you haven't already, please go back and read last weekend's Newsletter for a full understanding of both counts.
Lastly is some short and long term trendline analysis. Below is a weekly chart of the S&P500 showing the down trend from the top in January 2022 to the October 2022 bottom. We had an upside breakout in January 2023, and a retest of the trendline in late March of 2023 that gave us the second point of the emerging up trend. This up trend is still in place but intersects the 4200 level within the next couple of weeks. A close below 4200 and the up sloping trendline is extremely bearish.
Below is a long term trendline of the S&P500. If we connect the major lows from the bottom in 2009, we see that price is still well above this long term trendline. IF we are in the beginning stages of a major collapse, price is in wave D. An A-B-C-D corrective pattern takes price back to to the long term trendline in the area of 3350. While this would be viewed as disastrous (a 21% decline from Friday's close), it would only be correcting back down to the historical average. From this perspective, the long term bull market that began at the 2009 low would still be intact.
In the short term, we could still see a Q4 rally. The odds are getting much weaker after this week but its still a possibility. What's much more important is the long term. Even if we get a Q4 rally that takes the S&P500 to new highs, the S, I, and F funds will come no where near new highs. The C fund would be at such extreme overbought conditions given the macroeconomic backdrop that the collapse from those levels would be worse than a collapse from current levels.
Watch the short term but, you really want to focus on the long term. Friday's close below the 200DMA is the first major shot across the bow. Price is very likely to continue down for a bit then rally back to test the 200DMA line. A failure to get above the 200DMA line at that point puts us in the G fund for an extended amount of time, and using inverse mutual funds in the MFW... More to follow on this if we get there.
Have a great week!
The Grow My TSP Team