Tuesday, July 12, 2016

DOW and S&P Surge to New Highs But Hold the Champagne For Now

Two of the major indices, the Dow Jones Industrial Average and the S&P 500, surged to record highs today, closing at 18,347 and 2,152 respectively. While the overall market reaction since the swing low on 6/27/16 has been outstanding, and the chart looks very good from a technical perspective, we'd be remiss if we didn't take a step back for a moment to consider the entire landscape.

Dow Jones Industrials Daily Chart
The Chart

Let's start with the Chart. We've clearly pushed through overhead resistance with a vengeance.  Yesterday we plowed through short-term resistance that formed in April, and today we never looked back, breaking through resistance that dates back to May of last year.  From an Elliott Wave perspective, this up-thrust is showing clear impulse signs, both in the current pattern and in the longer pattern that started back in late June.  A very well-defined Wave 1 completed in April, and another well-defined A-B-C flat correction completed June 27 following the Brexit vote.  Since then, we appear to have completed sub-waves i and ii with wave iii of Wave 3 in progress.  If those patterns play out, there's a lot of good news ahead since wave iii has a projection of 18,645, and wave 3 could top out around 19,750.  That, however, requires a lot of optimism, and a lot of chips to fall into place in the world economy, and I'm not ready to suggest that those levels are in range at the moment.

The single item of concern on the chart right now has to do with volume.  It's been declining since the Brexit vote, and that could suggest a lack of commitment on the part of buyers. To push this market higher, we need demand to heat up, and so far - even today - volume is sitting well below it's 200-day average.


I'm hearing a lot of talk that today's surge is due to Brexit fears dissipating.  That may be true, especially with news that the issue of the next Prime Minister in the UK has been settled, however it's decidedly premature to dismiss Brexit altogether.  At some point, probably this quarter, Theresa May will invoke Article 50, setting the stage for the Brexit negotiations to begin in earnest.  The uncertainty that will generate is going to impact the global markets despite our pushing the issue to the back-burner for now.


Another explanation I've heard today is that there's optimism over the announcement of another Japanese stimulus.  While that's certainly good news given the state of the Japanese economy, we've been here before multiple times over.  The Japanese economy has been at death's door for several years, now, and another stimulus without a fundamental shift in the demand for Japanese exports is not going to provide much of a boost.

US Economy

The encouraging jobs report last Friday coupled with today's news that annual growth appears to be 2.4% is greatly reducing the fear of recession looming in the next twelve months.  There's also some encouraging indications that non-residential construction is increasing, and we may even start to see a burst in housing starts.  If we continue to add jobs at the rate seen in June, we'll likely see a boost in consumer confidence.  All of this is great news for the US Economy as a whole, although I'd still like to see a boost in hourly wages, as well as a significant jump in the Labor Force Participation Rate.

Looming over the US Economy, though, is a new concern that interest rate hikes could once again be on the table.  As better data start to emerge, the potential for a rate hike in September increases, and as that starts to gain traction we'll see an impact in the overall market. 

Also looming large is the strength of the US Dollar as well as the resumption in the bear market for Oil.  The dollar will continue to impact our exports and will continue to put negative pressures on earnings for companies with exposure overseas (i.e. most of the S&P 500.)  The resumption of oil declines continues to impact drilling and exploration, which in turn impacts the suppliers of that industry.  These headwinds will continue likely through the remainder of the year.

US Elections

What's still ahead of us is all of the uncertainty surrounding the US Elections.  Neither presidential candidate is anti-business, so from that perspective it's not likely that the Presidential election (or campaign) will be a drag on the economy.  The Senatorial Race, however, is a different story.  Control of the Senate is up for grabs in this election, and with it, the balance of power in the Supreme Court.  A significant shift to the left in those two institutions will have a definite impact on the market as investors and traders seek to adjust to the new dynamic.  Expect the Senatorial Race to add a measure of uncertainty as we enter the 4th Quarter.

The Bottom Line

The bottom line is, there are excellent reasons to celebrate the records set today.  There are also excellent reasons to be very cautious in our trading as we explore this uncharted territory.  There are some significant downward pressures that have yet to be addressed.  Until they are, I recommend keeping the cork firmly sealed in that champagne bottle.  Remember, markets never move in a straight line.  Eight of the last ten trading days have been up, and over half of them have been up with very wide trading ranges.  Expect the bill for that upward movement to come due in short order.

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