My message today is simple…
Bullish investors – and the risk assets they’ve been buying – face a daunting, uphill battle over the next four weeks.
Now, I don’t have a crystal ball and I don’t bother with forecasting. But that doesn’t mean I can’t “look ahead” into the future and make judgments about what is likely or unlikely to happen.
What’s more, I don’t have to rely on gut feel to do this “look ahead” analysis. I simply rely on the same objective, data-driven tools that underpin our investment strategy.
You see, in a court of law, the burden of proof is on the plaintiff.
The defendant is presumed to have the established “power,” so to speak – the presumption of innocence. And the burden, or onus, is on the plaintiff to prove otherwise.
The same relationship applies to sports competitions. The onus is on the underdog… to prove he’s better than the reigning champion.
And finally, I think of financial market trends in much the same way.
When a financial market establishes a persistent upward (bullish) trend… I presume that that trend will continue, indefinitely… until a downward (bearish) trend emerges and takes hold. That’s the essence of trend-following.
So let’s put this concept into the context of today’s market trends…
Since late last year, downward bearish trends have been prominent in a wide variety of risk assets. So even though bullish investors have had a nice run over the last two months… the longer-term, dominant trend is still bearish.
That means the onus is now on bullish investors – to prove they have the confidence and risk-tolerance to break the established downtrend… to dethrone the bears.
Now, this is where my “look ahead” analysis comes in.
Let’s take a look at six-month trends. The math is simple…
If today’s price is greater than the price six months ago… we’re in an uptrend.
If today’s price is less than the price six months ago… we’re in a downtrend.
Recently, a number of risk assets have crossed back into bullish (uptrend) territory. But the trouble is… those bullish trends might not last for long!
That’s because the reference price (that assets must exceed, to remain in a bullish trend) will be increasing dramatically over the next four weeks. Note: the reference price is simply the price of the asset six months ago.
A chart of the S&P 500 (SPY) should drive this concept home:
Currently, in determination of the six-month trend, the reference price is taken from October 5, 2015, when the S&P 500 (SPY) was trading at $198.
But over the next four weeks, that reference price will move up to $210 – a meaningful 6% increase.
So for the S&P 500 to stay in a six-month uptrend, it must continue to climb higher over the next four weeks. No rest for the weary!
Now, the S&P 500 doesn’t need to gain all that much over the next four weeks. But still, the onus is on the bulls to prove they have the will to bid prices higher.
And what’s more telling… is that many other risk markets have a much steeper mountain to climb.
I’ve done some “look ahead” analysis aimed at answering a simple question: how much would each market need to rally – over the next four weeks – for it to be in a bullish six-month trend four weeks from now?
Many of the required rallies are daunting.
The financial sector (XLF) would need to rally 8% in the next month.
The energy sector (XLE) needs to rally nearly 9% to be in an uptrend.
Within the energy sector… oil & gas subsectors (XOP and XES) need to rally between 18% and 19%.
And crude oil prices (USO) have virtually no shot at being in an uptrend come mid-May – it would take a 41% rally to get there!
I could go on and on… but all of the evidence points to the same conclusion.
Simply put: a majority of risk assets will be in bearish trends a month from now unless bullish investors prove to have remarkable stamina and power.
All told, my analysis shows it’s best to remain cautious as we head into May.
Adam O’Dell, CMT
Chief Investment Strategist, Dent Research