Farmers had a weathervane on top of their house or barn that told them which way the wind was blowing and give them an idea of what weather to expect. We need a MarketVane to tell us market direction.

The market had a very volatile week with the Dow down -2,300 points from its December 29th high as of the low at 15,450 on Wednesday. The rebound on Thursday was lackluster but buying picked up on Friday after the overseas markets exploded higher. Those same markets are higher on Sunday night but the S&P futures are down. Has the rebound run its course?

The answer to that question probably has more to do with oil prices than earnings, China or the FOMC meeting on Wednesday. Crude prices are the current driver of the market. When crude prices are in free fall the market tends to follow. The chart below shows that oil leads the equity markets. Crude prices are flat on Sunday evening but that may be temporary. The fundamentals in oil have not changed since the $26.55 low on Wednesday. Only the contract month changed and caused a short squeeze.

Crude prices are just one weight on the market. Over the last year the market has created a rounding top that could be the preview of things to come. The S&P decline last week to the October 2014 lows at 1,820 was met with an eventual short squeeze but it did not come the day after those lows. It was a delayed reaction and had more to do with Asia than a technical rebound.

In the chart below you can clearly see the rounding top in 2015 and the lower low on the S&P. If you had followed the strategy on that chart you would have been in/out of the market for the majority of all the gains and losses since 1995. That indicator is about to cross to the downside again for the first time since 2008. Obviously, we could see a miraculous recovery at any time that takes us to new highs but there are significant resistance levels above us that will take a significant change in investor sentiment to overcome.

Our "marketvane" for the next several weeks should be the S&P levels 1,950 and 1,867. If the S&P breaks out of that range that will likely predict our direction for the next couple of months. A break over 1,950 would trigger short covering by long time shorts and price chasing by funds. The fund managers cannot afford to let the market run away from them. The vast majority lost money in 2015 and they will be chasing performance in 2016 in order to redeem themselves in the eyes of management and investors.

If the S&P breaks below the August low at 1,867 it would suggest there are bigger problems in the market and the economy. Anyone left holding on to stocks they did not want to part with over the last three weeks would probably be racing for the exits on a new dip below 1,867.

I am not trying to scare anyone about market direction over the next few weeks. Nobody can accurately predict market direction routinely. The market exists to make fools out of the most people possible on any given day.

I only want everyone to understand the potential for further declines so they can make accurate decisions about their portfolios. The 7th year of a presidential election cycle is typically negative. There are too many last chance things a president wants to accomplish before his term ends and the candidates are giving long lists of thing they will change if elected. The long-term economic outlook in the 7th year is cloudy at best and normally turbulent.

The economic calendar for next week has two major events. The first is the FOMC meeting announcement on Wednesday. Nobody expects the Fed to hike rates after the market volatility and the meltdown in Asia. March is the next target date or even June for another rate hike. However, we never know how the Fed will phrase its statement and how the market will react.

The day before a Fed announcement is typically bullish in a trend called the Pre Announcement Drift. "Since 1994 more than 80% of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding FOMC announcements." Since the meetings only occur 8 months out of the year, that is a significant gain and it has been repeatable. This suggests we could see further gains ahead of Wednesday, assuming oil prices do not implode.

The second item on the calendar is the GDP on Friday. The Atlanta Fed is projecting a GDP of +0.7% and the second lowest reading of the year. That would put the full year GDP at +1.78% and below the Fed's expectations.

Economic Calendar

About the only thing we can count on next week is indecision. I would continue to suggest patience in adding new positions until we have a better idea on market direction. Being bored is a lot better than being broke.

Jim Brown

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