How will the S&P 500 Perform in 2018?Throughout 2017 the S&P 500 (SPX) constructed a strong uptrend with record low volatility as measured by the CBOE Volatility Index (VIX).
Uptrends of this magnitude and complacency are not uncommon. Reviewing where the market has come from will help us understand why it has behaved in this manner.
From the beginning of 2015 through the end of 2016 SPX was stuck within a trading range from roughly 1900-2200. This period was characterized by elevated levels in the VIX which were driven by two swift sell-offs in price during the summer of 2015 and the beginning of 2016.
When a market moves from the high in its range to the low of its range and then back again it can be categorized as a rangebound market. Typically, these are harder markets for traders and investors.
However, harder markets are followed by easier markets. As of late, the advance in SPX since the end of 2016 has created ample opportunity for profit.
Since SPX broke out to new highs at the end of 2016 the weekly chart has built a record run of higher closes throughout this year.
While the run-up in SPX has been impressive it is far from concerning considering that SPX was confined to a trading range for about two years.
Trading ranges create energy in a market as the buyers and sellers push prices back and forth. In most cases, the longer a trading range continues the stronger the move when the price breaks out either up or down.
In other words, think of this rangebound action like a spring that is being continuously compressed thereby building greater tension before it unravels. The more the spring is compressed and the longer a market trends sideways, the more energy is built up in both cases which ultimately leads to a swift move.
In essence, we have witnessed the SPX undoing two year’s worth of frustrating trading to create an uptrend from its previous range.
Looking at the daily chart of SPX we can see a series of higher highs and higher lows which defines an uptrend.
After emerging from the July and August 2017 lows SPX registered overbought levels on its Relative Strength Index (RSI). RSI acts as an oscillator that demarcates overbought and oversold levels.
During a range bound market these levels can be sold and bought, respectively. Conversely, when a market is trending up overbought levels can be interpreted as a sign of underlying price strength and oversold levels provide additional entry points.
While the ability of SPX to post overbought levels in RSI is encouraging, the speed of ascent since mid-November 2017 has increased relative to other trending periods during the past year. Previously, periods of a similar speed of price increases during an uptrend in 2017 have been followed by consolidation.
Markets can either consolidate through time or price. In other words, when the market slows down its rate of ascent it will either do so in a tight range around the recent highs or by declining to a previous level of resistance that will turn into support.
If the market is going to consolidate through price, the Fibonacci levels on SPX since the July/August 2017 lows suggest we could see a pullback to roughly 2500 to 2590. The latter level would correspond with the 100-day Simple Moving Average (100SMA) which acted as support during August 2017.
While SPX may be extended in the near-term, the move since breaking out in late 2016 is a sign of strength for traders as well as long-term investors.
Markets do not go up in a straight line so there will be periods of inevitable volatility and corrections in the future. However, as long as there is no meaningful damage done to the primary uptrend strategic asset allocators should use any pullback or consolidation as opportunities to commit new capital.
Specifically, until the trend on the daily chart begins to change its tone from an uptrend to consolidation and eventually to a downtrend, there will be very little damage done to the long-term uptrend. Accordingly, long-term investors should continue to consider any correction as volatility to ignore for the time being.
John DiRico is a trading and investment professional focused on technical analysis as well as alternative investment strategies. Additionally, he is the founder of the blog “A Discounted View” where he offers his observations on markets based on industry experience and topics covered in the Chartered Market Technician (CMT) curriculum. Please feel free to connect.