We start this morning’s post with a peek at the Russell 2000 as it perfectly illustrates the dilemma facing the broader markets this morning.
Up until September 2017, RUT followed a well-defined rising channel shown below in yellow. Like all channels, it was defined by the tops and bottoms along the way. The only problem: The channel was rising only about 5% per year – hardly enough to get excited about.
By late 2016, it had become obvious that algos had more influence than discretionary, fundamentally-oriented investors. The algos were, in turn, influenced by certain factors which central banks and their proxies could usually control quite easily. By wagging the tail (the factors) the whole dog (the market) would usually fall in line.
In September 2017, after RUT had been bumping up against the top of the rising yellow channel for over 9 months, the factors went to work and RUT broke out of the yellow channel and rose 21% over the next year. The slope of the new rising white channel was good for about 20% per year.
Everything was going well until September 2018 when RUT topped out at 1742 and plunged 27% in only three months. To make matters worse, the new rising white channel broke down and RUT fell back below the top of the yellow channel from which it had broken out.
It spent the better part of the next year trying to break out of the yellow channel again – failing seven times until Dec 4, 2019, when it finally shot above the channel top and remained there. There was a scare last month when, on Jan 31, it successfully backtested the channel top and bounced 5.5%.
Given yesterday’s carnage, though, it has fallen back to the top of the yellow channel where it faces that same important test all over again. If it holds, all is well and investors can go back to mindless trend following.
Even if it doesn’t, the SMA200 is now up to 1574, a modest 3.3% below yesterday’s close. But dropping through 1616ish would mean breaking down below the horizontal support (which served as overhead resistance between Oct 2018 and Dec 2019.) It could accelerate losses and complicate the rescue mission.
RUT is typical of many of the indices and individual equities I chart every day. The Dow, for instance, faces a similar test at 27,700.
And, SPX and ES completed important backtests (the purple channel top below) in the process of tagging our next downside targets yesterday.
Given the way the factors are behaving this morning, there is a good possibility that we’ll see additional backtest targets such as DJIA 27,700 tested today. But, that would mean taking a chance on the algos’ ability to rescue stocks from some very risky waters.
Stay tuned.
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