Michael Sincere's Long-Term Trader: This market can’t go sideways for long, so get ready for a breakout or breakdown

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Stock investors and traders should pay attention to how the S&P 500 reacts to the 200-day moving average (the average closing price of the S&P 500 (SPX) over the last 200 days). Generally, it’s bearish when the SPX is below its 200-day moving average, and vice versa.

The SPX SPX, -0.94% fell below its 200-day moving average last December 4, which caused massive selling by hedge funds, high-speed computer programmed algorithms, and regular investors.

Since its December selloff, the market has made a remarkable but questionable (more on that later) rebound to its 200-day moving average. This is a major pivot point, or in technical analysis, a major resistance point.

When the market is at a major crossroads like this, it’s too risky for traders to place a bet on which direction it will go. If the SPX moves strongly higher from here, that would be bullish. If the SPX fails to move much higher and reverses direction, that would be bearish.

Read: This cocktail of macro risks could cause downturn that ‘rivals’ global financial crisis

A wait-and-see approach is the most prudent. The great stock speculator Jesse Livermore made the most money when he correctly identified the market’s pivot points. He also lost a lot of money by plunging in too early. In this way, Livermore learned not to place trades before the pivot point, but instead to wait until he received confirmation of the market’s next move.

In other words, first see how the market reacts as the S&P 500 straddles the 200-day moving average. To help you decide what action to take, if any, here are some bullish and bearish views of the current market:

The bullish view: After the December market shellacking, Fed Chairman Jerome Powell reversed course and the Fed became highly accommodative. The Fed hinted it would hold off raising interest rates indefinitely, and might even reinstate QE (Quantitative Easing) if necessary.

The suddenly dovish Fed, with help from the volatility-killing algos and the White House, propelled the market to its 200-day MA. So long as volatility remains low, the markets will likely drift higher, perhaps higher than anyone believes.

Other bullish U.S. market news includes the positive jobs report, low unemployment, and low interest rates. In addition, investors who didn’t panic in December and held their stock positions were rewarded. Therefore, few investors are selling now as the market keeps rising.

The bearish view: The Fed hiked interest rates by a measly quarter-point and the market indexes plunged in December. Either the pullback spooked the Fed or they see something dreadful that we don’t know about.

In addition, market trading-volume is incredibly low and investor complacency is high, which is one reason why the algos have been so successful at gunning the market higher since the December lows. Moreover, the market is overbought again according to technical indicators such as RSI (it’s near 70 again, just like it was before the December correction).

Further bearish evidence comes from Lance Roberts, chief investment strategist of realinvestmentadvice.com. Although Roberts has been buying this rally from the lows, he points out the current risks: “While markets can certainly remain extended for much longer than logic would predict, they cannot, and ultimately will not, stay overly extended indefinitely. The important point is simply this. While the Fed may have curtailed the 2018 bear market temporarily, the environment is vastly different than it was in 2008-2009.”

Read: The evidence is in: Stocks are in a ‘bull trap’

Roberts points out other cautionary signs:

•        Unemployment is at 4%, not 10%+

•        Jobless claims are at historic lows, rather than historic highs

•        Consumer confidence is optimistic, not pessimistic

•       Corporate debt is at record levels and the quality of that debt has deteriorated

·       The government is running a $1 trillion deficit in an expansion not half that rate          as prior to the last recession

•        The economy is extremely long in a growth cycle, not emerging from a recession

•        Pent up demand for houses, cars, and other durables has been absorbed

•        Production and services measures recently peaked, not bottomed.

A wild ride

One big mistake I’ve made is a failure to imagine or prepare for how high or low the stock market can go. The SPX could potentially rise to 2800-3000 this year, while it could also drop to 2100 or lower. One thing is for sure: The market cannot go sideways for long, so prepare for a breakout or breakdown in the near future.

The last two months have been a wild ride. Said professional trader Mark D. Cook: “The market has gone from overbought to irrational exuberance in less than three months.”  Even though the market is technically overbought, it could go even higher, especially if investors remain complacent.

The key is how the SPX reacts to its 200-day moving average. Whether you are an investor or trader, watch whether the current bull market has the strength to power even higher, or finally succumbs to a bear market reality.

Michael Sincere ( www.michaelsincere.com ) is the author of “Understanding Options 2E” and “Understanding Stocks 2E.”

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