The S&P 500 carved out fresh 2016 highs Tuesday, a long way from the February doldrums that lead to widespread predictions of doom-and-gloom. The biggest question is if we should buy this breakout, or short the upper end of a summer trading range.
The day’s other big headline is oil closed above $50 for the first time this year. A nearly 100% gain in a few short months persuaded many to predict a continuation straight to $60. The problem with consensus is it’s rarely right. If everyone is convinced oil has another $10 of upside, then it seems like an easy buy. Unfortunately for us, very few things in the market are easy. This nearly universal bullishness makes me suspect a near-term top is just around the corner. No doubt we can get to $60, but most likely it will be bumpy ride with many confidence shattering gyrations along the way. Since oil’s breakout above $50 is an obvious buy-point, many oil traders have already bought and incremental demand will be harder to come by. With a scarcity of new buyers, what is going to push the price higher?
The story for the S&P 500 sounds a lot like what I just described for oil. While we’re near all-time highs, what catalyst is ahead of us that will convince people to buy stocks at record highs? A lot of institutional money managers are on summer vacation, leading to the typically lower volume we see this season. If big institutional money isn’t around to buy, who else has the firepower necessary to sustain a continued move higher? If we cannot answer that question, it is hard to get excited about this breakout.
This week the stock market rebounded from the slowest hiring numbers in half a decade. Rather than fear economic slowing, traders cheered the Fed’s postponed interest rate-hike. I don’t know about you, but I would more bullish if the Fed hiked interest rates because the economy was doing well, not the other way around. This excitement over a stagnant economy doesn’t make a lot of sense and is most likely only a reactionary phenomena. Delaying the second rate-hike a few months isn’t going to do much to improve corporate earnings and thus will have a limited impact on longer-term equity prices.
As for how to trade this, the last couple of days looked more like short covering than sustainable breakout buying. Shorts were forced to cover when we rose above their stop-loss levels. But often the point of maximum pain is where the market reverses. Surging to 2,120 would have led to widespread capitulation as most bears gave up ahead of the “inevitable” runup to all-time highs. But this afternoon the air was let out of the breakout as most of those early gains fizzled and we returned to near break-even. That lack of follow-on buying is a big red flag for bulls. We want to see people chasing this breakout, not taking profits. If we hold above 2,100 through the remainder of the week, then the situation looks good for bulls. But if we stumble back under 2,100 so soon after the breakout, look for a return to at least 2,080 and more likely 2,060. Trade accordingly.
What’s a good trade worth to you? How about avoiding a loss?
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Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.