Market Breakout

The SP500 finished at its highest weekly close ever on Friday. The breakout suggests significant upside exists over the intermediate term.

SP500 Breakout (Weekly)

The move comes after a very volatile 18-month period. Whatever you choose to call the recent digestion, whether its a bear market, consolidation, bull flag, etc, it appears to be ending with this new break higher.

Its important to understand when something is changing. Last week's rally doesn't mean the market HAS to continue to move higher but the odds generally favor higher prices after a pattern completion of this magnitude.

The S&P is trading 1% above where it was prior to the UK Brexit vote. This suggests to me that the sharp selloff following the news was nothing more than a counter-trend shakeout of overly optimistic bulls and eager bears thinking the world was coming to an end. I've heard quite a bit recently that the current rally is merely a bull trap, a "sucker's rally" before we roll back over and take out the February lows. While that scenario could play out it appears to me that Brexit was more likely the trap move lower, now causing the maximum pain to the majority of traders who tried to anticipate the fallout from the vote.

SP500 5-Wave

The secular bull market remains in process. Using a simple Wave analysis it looks like Wave4 is completing and Wave5 may be getting started. Honestly when we zoom the chart out like this it looks like an incredibly clean uptrend consolidation. The modest breakout that is trying to take hold here is put into a very interesting perspective from this view point. It doesn't seem so "bubbly" or irrationally euphoric when you just slide the timeframe out a bit.

A move to the next round number 3,000 would result in a nearly 50% move higher. It seems a bit outrageous at the current time, but it is certainly within the realm of possibility, and you must be aware of the chance. If you are completely blindsided by a strong rally emerging from this consolidation you will not be ready to trade it properly. "Its a bull market, ya know?"

The risk reward based on the long-term chart here is phenomenal. If we use the pivot low from June at 1,990 we risk 40 points for unlimited upside potential. Just remember regardless of what talking heads and perma-bears say, the market can certainly go higher from here. In 1988 the SP500 had just suffered through Black Monday and used the following 15-months to consolidate that shock. The previous 5-years saw a 300% rally once the 2-year '80-'82 bear market ended. The 1988-1989 consolidation kicked off a move from 300 in 1989 to a final peak of 1,550 in March of 2000.

Basically once the SP500 competed a pattern very similar to our current environment, it went on to post the largest bull market in US history; an 11-year 500% continuation move.

I'm not saying this is going to repeat, but to think that a similar rally ABSOLUTELY CAN NEVER HAPPEN AGAIN is foolish and an arrogant mentality to have. 

On the flip-side, If we are in fact on the precipice of disaster and this really is just a dirty trick being played on the Bulls, where are the more vulnerable signals coming from?

Its always good to be aware of the counter-argument in case that thesis begins to play out.

Concern #1: Transport stocks are weak

UNP

Concern #2: Energy has seen a bear market rally and is headed back to the lows

ENERGY (XLE)

Concern #3: Global equities remain vulnerable, industrial/material companies with heavy exposure to China especially, are setup to become a further drag.

CAT

These examples above are all trading generally lower over the past year+ and are just now testing the underside of their declining 20 Month SMA's. If the market were to roll back to the downside these groups appear vulnerable to leading the way lower. 

Stocks in this position should be treated with caution for now and with a tight leash on any open exposure. They could soon find themselves in a very similar spot as Financials.

The XLF (Financials) posted a similar pattern a few months ago before heading lower.

I remain Short both BAC and C, trends remain lower for now, but it should also be noted that the XLF was one of the top performing groups leading the market higher on Friday's advance. Should the Banks stabilize it could certainly provide a strong rotation to ignite more upside.

If they remain weak (as the longer-term charts still suggest) Banks will continue to add a divergence to the potential upside resolution for the market.

Bottom Line: All we need to know right now is that a potential shift is occurring. The SP500 finished at the highest Weekly closing price in history and most stocks are back in up trends. As long as the market stays above the 1,990 swing low we have to be looking for bullish opportunities.