Major indices are trading near all-time highs, but price development has been less than bullish, with narrow sideways action that has now stretched across six months. In turn, this compression has generated coiled spring patterns that predict large-scale movement, higher or lower, before the end of the fourth quarter. While "up" looks like the path of least resistance, this is a binary set-up, vulnerable to negative catalysts from the executive office or the Federal Reserve.
The trade war and the Fed share blame or praise for this holding pattern, which started after U.S.-China trade negotiations broke down in the second quarter. While that event triggered a rapid decline, continued strong job and GDP numbers have kept bulls in the game, buying the dips as forcefully as they did earlier in this decade. Taken together with falling interest rates, investors can find few reasons to sell their equity holdings.
However, this balance won't last forever, with high expectations for China and the United States to finalize a partial trade agreement in November. And, while the Fed is expected to lower rates this week, it's getting harder for Powell and Co. to justify a dovish policy, given continued U.S. economic strength. As a result, some or all of these metrics are likely to shift out of balance in the quarter, triggering the next big rally leg or a reversal that brings multi-month lows into play.
SPY Long-Term Chart (2009 – 2019)
The SPDR S&P 500 ETF (SPY) posted three rally waves off the 2009 low and reversed in the first quarter of 2018 after President Trump fired the first shot in the trade war. Price action since that time has crawled along the top of a shallow rising highs trendline that has added points at a surprisingly weak pace. The fund has just reached resistance for the fifth time, signaling the next leg of a test that generates a breakout to $350 or a wide-range decline exposing the 200-week exponential moving average (EMA) above $250.
Bulls have the obvious edge in this set-up, with daily, weekly, and monthly moving averages all ticking higher. In addition, there are unusual signs of life in the sleepy commercial banking sector, with Dow component JPMorgan Chase & Co. (JPM) breaking out to an all-time high after third quarter earnings. As a result, it makes sense to watch other banks after this week's Fed decision to gauge this group's relative strength.
QQQ Long-Term Chart (2009 – 2019)
The Invesco QQQ Trust (QQQ) posted impressive gains off the deep 2009 low, breaking out above the 2007 high in 2011. The uptick paused in 2015 and 2016, building a platform that broke to the upside after the presidential election. The fund shook off volatility in the first quarter of 2018, posting a new high at $187 in August. The pattern since that time is identical to that of the S&P 500, tracking a shallow rising highs trendline that has dampened 2019 returns.
A breakout above that resistance line faces an additional barrier at the psychological $200 level, which has narrowly aligned with a smaller-scale rising wedge pattern. In turn, these twin obstacles raise the odds for whipsaws and failure swings while bulls and bears decide the fate of tech stocks in the fourth quarter. Like the S&P 500, buyers have a modest advantage, raising the odds for continued upside toward $250.
The Bottom Line
The S&P 500 and Nasdaq 100 have coiled tightly against resistance in the past six months, raising the odds for a wide-range trend, higher or lower, prior to the end of the fourth quarter.
Disclosure: The author held no positions in the aforementioned securities or their derivatives at the time of publication.