Every Picture Tells a Story

Last week at this time the S&P was sitting close to the lows of the session and the market was down over 6% for the week. Fear over the election was escalating, and concern for rising virus cases had many market participants scaling back on risk assets. The market was having trouble digesting it all. Even without an election this week had its fair share of apprehension causing news, lockdowns in Europe, a Federal Reserve meeting, and the monthly unemployment figures. Now with all of this week’s potential pitfalls behind it, and the world still spinning, the market has reclaimed nearly all of the ground it lost during the last few weeks of October. For the week, the large cap S&P 500 index rallied an impressive 7.25%.

In last week’s note I mentioned that the market was delicately tiptoeing around critical support levels. Had the market failed to hold those levels it looked likely to potentially drop another 7-10%. However, starting Monday the market staged an impressive comeback this week, rallying nearly 9% from the lows on Friday. We have now entered a traditionally bullish season for the stock market. November through January represents, on average, the best return periods for stocks—on average being the key qualifier.

If last week we sat dangerously close to breaking key market support, today we are butting our heads against a key resistance level. In early September, the S&P’s rally from the March lows petered out around 3580 before falling back to 3200 in a matter of weeks. In early October, the market’s rebounding rally failed at 3530 before falling back to 3250. Now we are back to the neighborhood of 3510, forming what is known in technical circles as a wedge pattern or a pennant. The size of the pattern is significant, measuring nearly 10% at the base, which is notable because, according to technical analysis, the move following the eventual breakout corresponds to the size of the base of the pattern. Therefore, while we may continue to chop around in this pattern for a little while longer, once the market breaks out, we should expect a significant move in one direction. For visual contextualization here is the pattern to which I’m referring.

You can see that the market appears to be coiling up for a more significant trend producing move when it moves outside the range. While the existence of this pattern may only be of marginal interest to our readers, the direction of the breakout, I imagine, is of greater interest. I would say normally, these patterns are what technicians call continuation patterns, meaning the breakout is in the direction of the original trend--in this case it would represent an upside breakout.

However, technical analysis is far from science and sometimes it is more like beauty--more in the eyes of the beholder than something purely objective. For example, while one technician may see a wedge pattern, another may see a triple top—three failed attempts at making new highs. One is potentially bullish (wedge), the other is extremely bearish (triple top). The problem with technical analysis is that the true pattern is only really identified in the rear-view mirror. We really won’t know what this pattern really is until the market shows us what it’s going to do.

What I really like about this particular pattern, and its relationship to our current environment, is that it shows how the stock market manifests and tracks the current uncertainty. While the election may be all over except for the crying and the legal bills, there still remains a number of unanswered questions. First and foremost, we don’t know when this virus will go away and how bad this winter will be. The economy has proven fairly resilient up until now, but for how much longer can we continue to live on life support. If we knew the answer to that question perhaps the answer to the question of what kind of pattern this is would be clearer.

We also don’t know for certain what the longer term implications of a change of administration will be. Will the Republicans maintain their slight advantage in the Senate? If so, can they pass bipartisan stimulus legislation of ample size and impact? Finally, what will the future impacts for our economy and stock market when the bill collector shows up? In this simple chart pattern all of these questions seemed to be asked and seemed to be awaiting an answer.

While the world of finance is the world of data science and mathematics, occasionally it provides little glimpses of art. And we are left debating whether Mona Lisa was smiling or smirking.

Thanks for reading,

Zach and Dave  

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