Last night on Streettalk Live we discussed the ‘rising wedge’ of the stock market and the potential outcomes ahead. The chart of the day is the S&P 500 and rising wedge pattern that has been building since the 2009 lows.
While the upward sloping bullish trend line currently remains very solid support for the market over the last 4 years – each subsequent rally from this bullish trend line has consistently diminished. This entire push higher, of course, has been orchestrated by repeated interventions from the Federal Reserve and the diminishing rate of return has remained a concern of the Fed.
The important thing to understand about rising wedge patterns is that it produces a “price compression” much like squeezing a spring. The tighter the compression the bigger the move of the market will be when it eventually breaks out of the range. Therefore, one of two things will eventually happen; 1) The market will break out to the upside penetrating the long running upward trending resistance and began a parabolic move higher to an ultimate market peak, or; 2) the market will correct back towards the upward trending bullish support line OR break that support and begin a much bigger correction.
We know that this will eventually happen because this is how such patterns are eventually resolved. Furthermore, we saw this play out before in the run up to the market peak in 2008. As shown below – from 2004-2006 the markets traded within a fairly tight upward trending trading range. The upside breakout of that range led to the frothy top that was built in 2008. The rest, as they say, is history as the speculative frenzy, combined with much overbought conditions, led to a market decline.
From an asset allocation standpoint the trend is positive so we remain currently invested with a bias towards more defensive, dividend yielding, holdings. However, we are keeping a very close watch on the price action for any signs that may indicate a potential reversal of the current trend. While our current upside target for the S&P 500 currently remains at 1560 – that is only a gain of 2.5% from current levels. However, a normal correction to the upward trending bullish trend support line would result in roughly a 7% decline. The risk / reward ratio is hardly in the favor of investors currently and chasing the market at current price levels is likely to result in disappointment. While anything is certainly possible – as investors we must deal in probabilities when managing our savings rather than “hope” that some possibility may prevail.
As I have repeatedly stated in past missives – just because I point out the risks in the marketdoes NOT mean that we are not invested in them. We are. However, my job is to analyze the potential risks of being invested and determine when the best time to take profits, raise cash and reduce overall equity exposure is appropriate. No poker player goes “all in” every hand as it is a sure way to wind up broke. It is not so different with the markets. Being heavily invested into risk equities for the “long term” only ensures that the losses will more than wipe out your gains. Getting set back years in your retirement savings plan is not the way to reach your goals. If you are tired of that happening to you – start paying attention to the risks. This rising wedge pattern is one of them.
Images: Flickr (licence attribution)
About The Author
Lance Roberts – Host of Streettalk Live
After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.
Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.
Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.