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Everything Is Down

Written by Briton Ryle
Posted July 19, 2021

So OPEC actually agreed on a production increase and oil prices are down. 

Jay Powell and his merry band of Fed governors are changing their tune a bit. It’s almost certain — to me, anyway — that they will start winding down quantitative easing (QE) before the year is over. That’s the dreaded taper. And index futures were getting whacked this morning as I wrote. 

Malaysia’s government crushed 1,000 cryptocurrency mining computer rigs with bulldozers. So of course Bitcoin is down. 

And China is basically ending any new IPOs on any U.S. exchange. And the eventual possibility that all U.S.-listed Chinese stocks may get delisted has been discussed. Chinese stocks are… you guessed it… down. 

Last week, retail sales came in very strong, up 0.6%, when the grumpy men and women with calculators said a decline of 0.3% was in the cards. I guess all that shopping put people in a bad mood, because consumer sentiment was down (80 versus expectations of 86.5). 

Sorry, I wish I had better news for you, but it sure looks like the stock market is about to go “risk-off” — which is a kinder, gentler way to say “SELL!” so you don’t start any stampedes. 

I can’t tell you that this is the first step toward a 10%-plus correction for the stock market. But I can tell you that we are so overdue for a real bout of selling that we could see some really big down days in the near future. 

So, to prepare, let’s have a look at a chart…

That First Step Is a Lu-Lu

Now, any chart reader will tell you that it’s a bad idea to go “all-in” based on what you see — or don’t see — on a chart. It’s all about percentages, playing the odds. 

If you accept that trees don’t grow to the sky and that what goes up must come down, then you know corrections are inevitable. At some point, investors will decide to turn their stock profits into actual cash. 

The only question is when. 

So the point of doing a little chart analysis is to try to identify when stocks are overbought and investors may be ready to take a little break from the feeding frenzy.

I try to keep charts simple: three moving averages and maybe a relative strength index (RSI) oscillator. RSI is a decent way to gauge when stocks are overbought or oversold. 

On this six-month S&P 500 chart…


I have the eight-day moving average (MA) in green, the 50-day MA in purple and the 200-day MA in blue. The RSI oscillator is at the bottom. 

Really, we could do without the eight-day MA, because it’s really for short-term trading. And while we’re at it, we could toss the RSI oscillator too. I mean, does anybody think that stocks are anything but overbought and have been for like a year? 

Hyperbole aside, the RSI can still be useful. Stocks are considered to be overbought when the oscillator is at the top of its range, around 80. 

The most important thing about RSI is that it is NOT predictive. Just because stocks are overbought doesn’t mean there’ll be an imminent reversal. In fact, stocks often make the biggest gains when RSI is at the top of its range. [Editor’s note: You can always spot a novice chart reader if they use an overbought RSI as a justification for a downside trade. Think about it: Why does a stock index get overbought? 'Cause people are buying. Always respect inertia.] 

The moving averages are widely used as trendlines. This is important because I have yet to see a trading algorithm that doesn’t have a healthy respect for MAs. Just look at how many times the S&P 500 has bounced off the 50-day MA (purple line) in the last six months…

The 50-day MA measures the medium-term trend. But perhaps more importantly, it is a magnet. Once selling starts, the major indexes will almost certainly head for the 50-day MA… which might’ve been a good thing to know this past Friday.

Now, the machines will very likely stop somewhere around the 50-day. The S&P 500 has already gotten there today, and I wouldn’t expect too much more downside TODAY. 

Then there’s tomorrow and the next few days/weeks…

Thin Blue Line

Any correction worth its salt will take a stab at the 200-day MA. That’s the long-term trend, and if the machines can put the fear of God (and a trend change) in individual investors' minds, you bet they will. 

The 200-day MA for the S&P 500 is down around 3,900. Another 350 points lower. And they will be painful points…

But no pain, no gain, they say. And you don’t get opportunity without a little blood in the streets. After all, we want to buy low, right? 

Right. 

Bottom line for me is that there is no need to rush into this market. Investors have been ignoring a lot of stuff for the last, um, year. 

QE has to end, rates have to rise, and stocks are expensive. Plus, the current earnings season is peak earnings in terms of year-over-year comparisons.

If you need to lighten up, sell Chinese stocks first. Well, GameStop first, if you own that flea-bitten varmint. (And I’m using GameStop to cover any speculative, trade-type position you may have.) 

Then Chinese stocks. Next up, perhaps oil stocks. Then those “reflation trade” stocks. Banks definitely won’t do well here, but I’d probably just hang on to banks. 

There you go. Hope that helps. Oh, wait, one more thing — if this is a correction that will test the 200-day MA, we will likely see some big, ugly down days. That’s what happens when the machines are all marching in lockstep. Don’t panic.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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