Today’s 1000 plus point drop in the Dow Jones Industrial Average is largely being attributed to increasing fears over the possibility that the Corona Virus could be the final straw that forces the US Economy into recession. Late last week there was lots of chatter in the investment community that the growing threat of an actual pandemic was not being properly reflected in stock prices. While we do not yet think that the Corona Virus will be the catalyst for an eventual recession, we do think that ignoring the possible slowing in related corporate earnings is a mistake. Therefore, we think a defensive posture towards risk is appropriate. Defensive is client specific.
At Emerald Asset Management, we use fundamental analysis to look for value and to decide on the merits of particular investments. Fundamentals are basically the story and tell us what to buy. We think that the fundamentals that have been supporting the current long-term bull market in stocks are still in place but the Corona Virus concerns elevate short term risk to the downside in equities.
In order to pick entry and exit points in the stock market we turn to the charts for shorter term guidance. Said differently, the charts tell us when to buy or sell. To the experienced eye, it looks like the S&P 500 might be forming a chart pattern known as a Head and Shoulders top. For that to happen, stocks should form a right shoulder (S2) with a bounce from around the January low of 3214 (neckline) to somewhere in the neighborhood of 3337 which is the level of the top of the left shoulder (S1). A decisive break of the lows at 3214 would confirm the pattern which projects to about 3034 which is near the December low of 3070.
There is a Wall Street axiom that seems to work pretty well. The adage is that if the December lows are not violated during the first quarter of the following year then all is well. In order to turn longer-term negative, stocks would need to decisively violate the December lows for at least a day or two in our opinion. If stocks do put in the anticipated right shoulder and don’t break the neckline at 3214 then a very powerful continuation pattern will have formed indicating that the S&P 500 has successfully consolidated and should set the stage for higher prices going forward.
Our current plan is to remain patient; honor stop losses and see if the 3214 area holds after an anticipated bounce this week or next. If that level doesn’t (and we don’t think it will) we will watch the 3070 area and do the same. A successful retest of the 3070 level would be about a 9.55% correction which is both normal and healthy. It is very important to understand that our position is that US Equities are in a normal correction and that the long-term bull market is alive and well.