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Santa's Coming to a Market Near You!

Written By Briton Ryle

Posted December 16, 2014

No matter which way you look at the stock market, fundamentally or technically, indications are pretty strong that the recent pullback is very close to ending, perhaps as early as the latter half of this week.

Given the recent 4.3% plunge in equities over the past two weeks, traders had been doubting whether Santa Clause would show up this year with his traditional year-end rally. Yet with some positive economic reports yesterday, many are now putting their hands to their ears to ascertain if what they are hearing off in the distance are indeed Santa’s jingle bells getting louder by the day.

While yesterday’s four economic reports were mixed – two positive and two negative – the winter season now being upon us might show the negative reports to really be not so negative at all, but par for the course.

We also have at least three positive developments on the technical charts pointing to an end to the current pullback soon. There is just one more indicator missing from the charts to seal the deal and allow us to declare the pullback officially over. Until we see that one last sign, we can’t quite call this turkey completely roasted just yet. But we’re close.

Let’s start with the fundamental reports before getting into the technical charts.

The Recovery is Fundamentally Sound

Four reports were released yesterday morning, two positive, both for November, and two negative, both for December.

• November’s Industrial Production came in at +1.3%, higher than the +0.9% expectation, and up more than a full percentage point from October’s +0.1% reading.

“Thanks to strong consumer goods and utilities output, industrial production in November rose by the largest percentage since May 2010,” Market Watch reported. “Data was also revised up for the past three months.” “Production is up 5.2% over the past year.”

Naturally, such strong increases in industrial production mean more economic activity, growth and expansion, driving up the figures of the companion report that came out with it:

• November’s Capacity Utilization rose to 80.1%, higher than the anticipated 79.4%, and higher than October’s 79.3% utilization.

“This is the highest level since March 2008 and equal to its long-run average,” Market Watch elaborates. “This may be a sign that the ample slack that existed in the economy in the wake of the financial crisis has been taken away.”

Simply put, capacity utilization measure how much of America’s factories are currently being used. Running at just over 80% of maximum output is better than we have seen since the recession six years ago, a sign that the U.S. recovery is still accelerating and running strong.

That’s all fine and well, but before we bring out the eggnog for a toast we still have two other reports to factor in:

• December’s Home Builders’ Index came in at 57, lower than the 59 expected, and lower than November’s 58. This a poll of construction companies, which is designed to get a feel for how they feel about the current state of construction, whether they are optimistic or pessimistic looking forward. A reading above 50 indicates optimism, while below 50 indicates pessimism.

Yet while the home builders’ optimism ticked lower in this most recent survey, it is still near the highest level since the housing market collapsed in 2008, having just this past September hit a nine-year high of 59.

This month’s reading of 57 is still pretty darned good as it marks the sixth month in a row with a reading over 50, which is “consistent with our assessment that we are in a slow march back to normal,” confirmed David Crowe, chief economist at the National Association of Home Builders which conducts the survey.

• Finally, December’s Empire State Manufacturing Index registered -3.6, down sharply from an anticipated expansion of +12.0, as well as being down from November’s +10.2, with readings above zero indicating improving conditions in manufacturing while readings below zero indicate contraction.

“This is the first negative reading since January 2013 and came as a surprise to analysts,” Market Watch reported. “Readings during the fourth quarter show a significant downshift in activity from levels seen in prior two quarters, the New York Fed said. The index had stood at 27.5 in September.”

The report was accompanied by two more sour numbers, as “the new orders index and shipments also turned negative in December.”

To sum it all up, then, we’d have to call these reports favorable overall at 2.5 out of 4, with the Industrial Production and Capacity Utilization figures being decidedly positive, New York’s Empire State Index being decidedly negative, with the Home Builders’ Index being something of a half-positive, since its reading is still close to an almost one decade high. And of course, we are entering the winter months, when construction is naturally down.

But while these reports indicate the future still looks bright, what about the near term? Is the recent pullback in equities going to continue through to the end of the year? Or might we be near its end? This is where the technicals come in.

Santa’s Close – Technically Speaking

The first and most obvious signal the charts are giving us to indicate the current pullback is nearing an end is delivered by the Slow Stochastic, as graphed below. Measured on a scale of 0 to 100, a stochastic reading below 30 is considered oversold and tightly coiled for a rally, while a reading over 70 is overbought and ripe for some profit taking.

Currently the slow stochastic is reading below 15, indicating extremely oversold conditions which could spring upward any day now. As noted in orange, whenever the stochastic fell to 15 and below, the market hit bottom within just a few days. And here we are again.

Three signals santa


Next we have some moving averages to consider, namely the 150-day average colored in orange below, immediately above the yellow 200-day average.

Very simply put, in a bull market the S&P seldom breeches below its 150-day average. Over the past two years, in the eight previous times that the S&P has fallen through its 100-day moving average (arrows), only once did it fall through the 150-day average as well (final arrow).

So here we are again, having fallen through the 100-day average and sitting on the 150. Will we fall through this time like we did in October? The odds are saying no. But even if we do fall through again, we know this much… being as close to the 150-day average as we currently are shows we are much closer to the end of the pullback than not.

100 day average santa


Next we have the Moving Average Convergence Divergence, or MACD, as graphed below. In this index, readings below zero indicate oversold while readings above zero indicate overbought. However, the index’s placement above or below zero isn’t as important as the direction in which its two moving averages are moving.

The two averages making up the MACD will generally move as the market does, moving down when the market falls and moving up when the market rises. Generally speaking, the time to jump out of the market is when the MACD is above 10 or 20 and has just begun cresting downward. Conversely, the time to jump in is when the MACD is below 10 or 20 and has begun turning upward.

But the MACD is a lagging indicator, since it is comprised of backward looking moving averages. Hence, the MACD doesn’t turn around soon enough to be an effective gauge in determining when to jump in or out of a market. Instead, the best the MACD can tell us is whether to “stay” in or out a little longer.

Seeing as the MACD is currently above zero and still pointing down, we would consider this a sign to stay out of the market a little longer. However, the fast moving average (blue) is very close to crossing below zero into oversold territory, indicating we could be about a week away from a great entry point.

Just remember that, as noted in purple, the MACD does not necessarily need to be deep below zero for the market to bottom. Sometimes a shallow dip into negative territory is enough to signal a buying opportunity, especially in a bull market.

MACD chart santa


But there is just one more signal we’re waiting for to indicate that the time to jump in has arrived, and that is what the arrows above are pointing to. In each of the previous larger pullbacks, the correction could not be considered over until the market had a very clean “up-day” when it closed at or near the high for that day, and above the highs of the previous few days. When that decidedly up-day came, the market remained above that day’s close (above the arrow) for weeks and even months.

That’s what we’re waiting for now… a strong closing where the S&P closes decidedly up near the high for the day, which we have not yet seen during the current pullback. However, all indications put together are telling us that we are getting close to such a decidedly strong close. When it comes, be ready to jump in the very next day, or after hours the same day if you can.

Grinch Be Gone

With the holidays less than two weeks away, it may look like the Grinch is going to steal our holiday cheer this year. But yesterday’s economic fundamentals are telling us that the future still looks bright, and the technical charts as signalling that the near term looks close to turning.

There may still be a few more days of sorrow. But with the Federal Reserve’s FOMC meeting now underway until tomorrow, look for the central bank’s consistently upbeat press release on Wednesday to give the markets a boost as it usually does. The end of the pullback which the indicators are pointing to may come as soon the end of this week, if the Fed has anything to say about it.

Joseph Cafariello