The Selloff

The S&P 500 closed at an all-time high of 2872.87 on Jan 26…and has been in freefall since.  So what the heck is going on? Well, at Maestro Capital Research, we believe this is merely a healthy bull market correction and that we have possibly witnessed the selloff’s capitulation during the Feb 9 trading session. Here are our thoughts:

Corrections can be healthy
For long-term investors saving for retirement, it’s been a fun upward ride for the last several years (not as much fun for active traders who prefer volatility). As a reality check, the S&P 500 hasn’t experienced a correction greater than 6% in 2 years. Last time we saw a drawdown of this magnitude, the S&P 500 suffered a 14.5% pullback from Nov 3 2015 to Feb 11 2016. We believe pullbacks of this magnitude should not only be expected once or twice a year, but are healthy, especially after the near vertical run-up we’ve seen since the first of January (Santa Claus and his annual rally just kept on ho-ho-ho-ing along well into January). Historically, when price versus the 50-day simple moving average (SMA) exceeds 6%, consolidation and/or a selloff commonly follow. On Jan 22 through Jan 26, the S&P 500 crested 6%.

No yield curve inversion…yet
We mentioned this on our Jan 7 blog: the last couple of major market tops happened soon after short-term treasury yields exceeded rates on the 10-, 20, and 30-year bonds. Why does this happen? Basically, investors believe the long-term economic outlook is bad and that a reduction in yields on longer-term fixed income investments is imminent. Whether or not the predictive power of a yield curve inversion is lessoning has been debated, but we believe it should remain one of a handful of factors to watch for.

It’s “Hammer-time” (sorry, I couldn’t resist)
Yes, this beloved candlestick pattern is what many successful market technicians look for before a near-term trend reversal. After another wild ride on Feb 9, a bullish hammer formed into close, leaving us to believe that an end to the selloff is nigh:

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Best 8-days
For those who contribute to a 401K plan through their employer, funds are systematically deducted from their paycheck and invested into pre-designated equity or bond funds (along with employer match dollars, if applicable). When does this happen most frequently? On the 1st and 15th of each month (and the handful of days that straddle those days), a significant chunk of dollars flows into the stock market. That’s obviously bullish…and the 15th is coming soon.

Decreasing volume
As you can see, volume over the last few days of this selloff has been decreasing. This price/volume correlation is a common sign of an impending reversal:

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Elliott says so
Although at Maestro Capital Research we don’t put a huge amount of weight on Elliott Wave Theory, we do like to take a broad and balanced approach to our analysis, looking at multiple technical patterns, data points and concepts including EW. In the left image below, notice the classic 1-2-3-4-5 wave pattern (with wave 3 always the strongest), then a-b-c reversal. The image on the right shows the current S&P 500 chart with our pattern labels. Despite the sometimes subjective nature of EW wave labeling, we do see a compelling case for a bullish a-b-c reversal:

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Note that many of the points mentioned above factor into Maestro Capital Research’s flagship Forte Strategy which is available for subscription through Collective 2.  For more information, click here!