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The stock market has been detached from economic reality. Investors, drunk with “hopium,” bored at home and unable to bet on sports, have turned the stock market into a casino.
The stock market always looks ahead. It’s sensible for investors to gaze beyond the valley caused by the coronavirus toward good news on earnings in 2021 and a vaccine for the deadly virus.
Pfizer PFE, +5.16% has released promising early results on a coronavirus vaccine, along with partner BioNTech BNTX, +5.10%. Other companies are also in the running.
However, such optimism does not justify the extent of the strong stock market rally from the lows. The real impetus behind the market’s strength is money printing by the Federal Reserve and borrowing by the government. Now politicians have set up the stock market for a decline this month. (More on this below.) You can expect more stimulus and support to keep the stock market rising.
How might things play out? Let’s explore with the help of a chart.
Chart
Please click here for an annotated chart of the Dow Jones Industrial Average DIA, +0.27%, which tracks the Dow Jones Industrial Average DJIA, +0.16%.
Note the following:
• The chart shows an island reversal.
• The island reversal pattern has been accompanied by high volume, the Arora sentiment indicator giving a sell signal, an inside day following the island reversal, RSI (relative strength index) at an extremely overbought level of 95 and the smart money selling near the highs. All of the foregoing makes this an especially important pattern to watch.
• The chart shows the resistance line.
• In a separate pane, the chart also shows the resistance line for S&P 500 ETF SPY, +0.68%, which tracks the S&P 500 SPX, +0.45%.
• The chart shows that in spite of several strong rallies, the stock market has not been able to break the resistance line. The stock market will have to break the resistance line and stay there for at least a few days before going higher than the island to negate the negative pattern.
• Before turning bearish because of the pattern described, know that the whole pattern can be negated in a jiffy on good news on a vaccine or more money printing and borrowing announcements from Washington, D.C.
• This stock market has been controlled by the momo (momentum) crowd.
• The chart shows in the RSI pane that the stock market has lost its momentum.
• The chart shows that volume is consistently not high. Compare the recent volume to the volume on the day that the island reversal occurred, as shown on the chart.
• The chart also shows in separate panes the price action in two of the momo crowd’s favorite stocks: American Airlines AAL, +2.44% and Carnival CCL, +1.88%.
• The chart shows both stocks have lost their momentum, and the momo crowd is now sitting on big losses.
• Usually, the price at which a secondary offering takes place offers support. American Airlines’ secondary took place at $13.50, as shown on the chart. The expectations were for the stock to bounce hard after the secondary. However, the stock has persisted below the secondary price.
• Unlike the momo crowd’s favorite stocks, the big money is hiding in the five large-cap tech stocks of Apple AAPL, +0.57%, Amazon AMZN, +1.44%, Microsoft MSFT, +0.59%, GOOG, +1.48% GOOGL, +1.36% and Facebook FB, +2.33%. The five stocks have stayed resilient. Prudent investors should carefully watch the charts of the five stocks for the first signs of a crack in the hopium bullishness or the first signs of another stock market bullish leg up to new highs.
• For more perspective and key price points, please see “Watch these two important levels in the stock market to see which way prices may go.”
Importance of July
Without any new developments, here is how politicians have set up July for a stock market decline:
• The money that flowed into the economy from the Payroll Protection Program (PPP) was initially set to be used in an eight-week period. This has now been extended to 24 weeks. However, for a vast majority of the recipients, the money will be used up this month or has already been used up. The deadline for new loans from PPP was June 30. Now the deadline is in the process of being extended. Those who already have this loan cannot apply for more money. There is approximately $130 billion still unspent in the program but there is tepid demand for it. This is an early sign that the economy may not absorb the money even when it comes with very liberal conditions.
• The government provided an extra $600 per week in unemployment aid. This extra aid is set to expire in July. Not to worry: Politicians thought it appropriate to give a large number of people more money to not work.
• Politicians managed to politicize the use of masks and accelerated the spread of the coronavirus in several states. If the current trends hold, the number of coronavirus cases can get to scary levels in July.
• Politicians also politicized the reopening of the economy with an eye to the November election, as opposed to basing the reopening on sound principles of economics and science. The consequences of this politicization may become more evident in July.
• The Fed has already announced a broad range of programs financed by money printing. Some of these programs are meeting tepid demand. This is, again, an early sign that there is a limit to the benefit of the Fed’s programs. Not to worry, the Fed is hard at work racking their brains in trying to figure out how to solve the real problem — the solvency of zombie companies and a large number of Americans. Loaning money to insolvent borrowers does not solve the problem.
Disclosure: Arora Report portfolios have positions in Apple, Amazon, Alphabet, Microsoft and Facebook. Nigam Arora is the founder of The Arora Report, which publishes four newsletters. He can be reached at Nigam@TheAroraReport.com.
