What’s Happening?

Since the US election, US stocks have been on fire and the NASDAQ has been leading the charge. With a higher weighting in momentum and technology stocks and a lower weighting in defensive sectors, the NASDAQ often leads moves in both director and provides a good barometer of sentiment at the margins. Recent technical action in the NASDAQ suggests upward momentum may be near exhaustion and a correction possible.

 

Technicals:

Since US election night the NDAQ has been on a tear rallying from a low near 4,575 toward a high near 5,400. Advances have come in stages with rallies followed by periods of consolidation at higher levels.

The last run up into the 5,300 to 5,400 has left the index highly overbought and vulnerable to a potentially deeper correction. The RSI did not confirm the last run to new highs, a negative divergence that indicates upward momentum slowing. More recently, the RSI has dropped under 70 from overbought territory a technical signal indicating slowing upward momentum and a correction starting.

The index is also starting to break down. It appears to be breaking one uptrend support line near 5,360. Channel support appears near 5,300. A failure there would signal the start of a new downtrend that could test 5,200 where Fibonacci support (23% retracement of the post-election rally) and a flatter uptrend support line cluster.

 

Fundamentals

The big gains in US stock markets in recent months have been fuelled by three main factors:

Anticipation that policy initiatives from the Trump Administration would have a positive impact on the US economy, particularly tax reform and infrastructure.

Reduced fears that Trump policies on trade and health care could cause widespread disruption to the US economy.

Major inflows of capital from retail and institutional investors that had been sitting on the sidelines not wanting to be left behind in a rising market.

These factors created a perfect positive storm for stock prices but as enthusiasm turns into euphoria and developments get fully priced in, the risk of a correction grows. Factors that could spark a correction include:

The speed of government is glacial compared with the speed of markets. At some point traders could start to demand more details or lose patience with the process and start to take profits while looking for the next trend to play.    

It seems like President Trump is getting price to perfection. Signs of bumps in the road, oppositions, or other developments taking the President’s attention away from the economy (Russia, travel bans, wiretapping, media coverage, etc) could spark a correction.

So far the bears have been steamrolled by the flood of capital coming into the markets but should the inflows recede, we could see a pullback.

Overall the balance of potential surprises appears to be tipping toward the negative following last week’s speech. Traders this week may also start to focus on next week’s Fed meeting with a rate hike now widely expected whereas a couple of weeks ago it had been widely dismissed. This week’s Wednesday ADP payrolls and Friday nonfarm payrolls could also spark significant trading action in the markets.