Which Way Wednesday – S&P 2,940 or Bust (again)!

Will the 2nd time be a charm?

The S&P 500 will make another attempt at getting over the 2,940 line, which is 33.6% higher than our old "Must Hold" line at 2,200.  33.6% is not particularly significant, the real significant line is the 20% line at 2,640 and we haven't seen that since April and now we're over the 30% line (2,860) and it's probably time to move the goal posts as those lines were for the end of 2017 and the tax cuts have been a game-changer for the S&P 500 and anyone else who measures their earnings in Billions.  

Companies aren't making more money – they are just paying less taxes but same difference to investors – as long as more goes to the bottom line.  I'm not saying that 2,860 is likely to hold in the long run but, taking into account buybacks and repatriation of capital (ie tax avoidance) and lower tax rates – 2,640 is a reasonably good "Must Hold" level for the S&P going forward as the Must Hold Line represents a bearish break if it fails and 20% above (3,168) and 20% below (2,112) is the expected range the market should stay in.

Getting close to 3,000, it's hard to imagine 2,112 ever happening but I suppose we said that in 2000 and again in 2007, when the S&P was up at 1,550 and both times it fell 50% within the next two years.  This time is different though – we're 50% higher now so, even if we fall 50%, we still end up back at the previous highs – that's progress! 

Image result for s&p 500 pe ratio 2019

That's right, we're getting very close to that magical 3,000 level which, appropriately, would price the S&P 500 at 30 times it's trailing earnings but, if we assume forward earnings will go up and up forever and nothing will ever, ever, ever go wrong – then it's only 27 times earnings and that seems like a bargain these days, right?

Image result for stock market bubble chartAs you can see from the chart above, 30 on the CAPE index has popped every bubble since 1903 except
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Tuesday – Trouble at 1,700 for the Russell

What's wrong with small caps?

All the other indexes seemed pretty happy yesterday but the Russell 2000 fell 1.5% and are down even more this morning in a non-stop UGLY day of trading where almost every candle formed on the hourly chart was a down one (and the up ones were pathetic).  Volume was also almost all red and much stronger than Friday's up volume, which was completely reversed by noon.  

So far, this is just a natural rejection of the Russell's 10% run for the year, which began at the 1,550 line on Jan 2nd so 10% from there is 1,705 and that's why we have been shorting the Russell below the 1,700 line, looking for that rejection.  According to our 5% Rule and rounding off to the more significant 1,700 mark, a 150-point run expects a 30-point (20% of the run) rejection so 1,670 should be a weak retrace and that's all this is so far.  Another 30 points would be a strong retract (1,640) and still not really bearish unless we fail it.  As noted in Friday morning's PSW Report:

Notice on our Big Chart that the Russell has failed its 50-day moving average at 1,700.  There's nothing bullish about the market until it takes that back and watch out below if any of the others fail to confirm a new downtrend but, as I said, not today – today we have to make the quarter look pretty so we can bring some fresh retail suckers in to hold the bags next quarter

Remember, I can only tell you what is likely to happen and how to make money trading it.  A 30-point drop in the Russell is good for gains of $1,500 per contract and, since we expect a bounce off the weak retrace at 1,670 – we already know where we're likely to stop out.  Now that we have that range, we look at the 40-point drop from 1,710 (because we can't round off in the short-term picture) to 1,670 (but we do use the goal line – even if it doesn't actually hit) and now we look for a weak bounce – which is 20% of the 40-point drop – to 1,678 and a strong bounce to 1,686, which we have to clear before looking bullish…
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