The Standard and Poors 500 index (SPX) took a serious hit on December 1st due to the double whammy of what turned out to be a false news story about Trump and some concerns that the tax bill had hit a wall. The concerns that tax reform would not be passed continued to haunt the market on Monday. Many of the high-tech darlings that have performed so well this year were badly hurt on one or both days. But Thursday brought a new optimism to the market and SPX even gapped open higher on Friday morning.
Market analysts have been debating whether a presumption of passage of a tax bill has been “baked into” the current market prices. I have certainly found my thinking to waffle back and forth on this question, but recent market price action has convinced me that a failure to pass the tax bill this year will result in a pullback in the markets. The questions are the degree and duration of the pull back.
The most recent earnings cycle certainly documented solid corporate earnings growth, and that is the foundation of a strong bull market. But it is also true that several technical indicators have been suggesting an increasingly overbought market.
SPX opened Monday at 2657 and that tied the intraday high on November 30th. SPX closed Friday at 2652 so we have spent the last seven trading sessions trading sideways. This level of the market is the tipping point between higher prices upon passage of the tax bill and lower prices if it fails to pass. How much lower? That is hard to predict, but I will be looking at the support levels on SPX at 2596 and 2565. I think it is unlikely for the market to break those support levels.
Consider the pattern of trading volume for the S&P 500 companies. Recent trading volume has been relatively low, running at or slightly above the 50-day moving average (dma). When the market tanked on 12/1, 12/4, and 12/5, trading volume spiked higher. But when the market strengthened on Wednesday through Friday of this week, trading volume fell below the 50 dma. That pattern suggests that many more shares are prepared to be sold on any sign of weakness than are willing to “go all in” on a perception of strength.
The Russell 2000 Index (RUT) displayed a strong run for the last half of November. Many attributed this to a perception that the tax reform bill would be more helpful to smaller companies, such as those of the Russell 2000 index. And this perception appears to have been validated by the price behavior since December 1st. Once passage of a tax bill began to be doubted, RUT traded lower. Look at how far RUT fell on Friday, 12/1, touching the 50 dma before bouncing back higher. Wednesday’s price action broke support set by the early October high and the pause on November 21-27. But Thursday and Friday recovered some of those losses, closing at 1522 on Friday.
The volatility index for the Standard and Poors 500 index, VIX, spiked to an intraday high of 14.5% on December 1st, but began a steady decline this week, closing Friday at 9.6%, near lows for the year. This completed a full cycle from the low of 9.7% on November 24th to the high on 12/1 and back to 9.6% yesterday. VIX primarily reflects the perceptions of the large institutional traders. For now, at least, they are very complacent.
Where do we go from here? Many of our high flyers were taken to the wood shed last Friday and Monday of this week. But we seem to have recovered by week’s end. Passage of a tax bill will certainly push the market higher, but it could be a “sell the news” moment. The price action of the past six trading sessions suggests a sell off of some magnitude if the tax bill fails to pass out of Congress.
This coming week features the FOMC meeting and announcement and the expectation of a decision on the tax bill by Friday. We may be in for some choppy sideways trading until the fate of the tax bill is finally known. Keep a close watch on your positions and set tight stops. This is a nervous market and this week could bring some big moves higher or lower.