foxex: Resistance

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Monday's Headlines

1. Stocks tumble as early rally meets resistance

Markets Close

Dow
25,819.65 -0.79%

S&P
2,792.81 -0.39%

Nasdaq
7,577.57 -0.23%

VIX
14.63 +7.81%

INV Anxiety Index
99.68 Neutral

US 10-Yr Yield
2.722 -1.20%

Photo credit: Getty

Resistance

Monday had all the trappings of a major market rally as news of continued progress in the U.S.-China trade talks propelled Asian markets higher. Stocks rallied out of the gate in the U.S., but hit a major wall of resistance at around 10am. Some media outlets attribute the abrupt turnaround to a worse than expected report on construction spending for the month of December, issued by the Commerce Dept. It showed a decline of 0.6%, while economists, on average, predicted a gain of 0.2%.

That may have been a factor, but it's hard to believe such a slight miss on a report about December construction spending carried that much weight. It's more likely that stocks rallied up to a key resistance level, and couldn't breach it. That level, 2800 for the S&P 500, has been a key focus for traders and investors since the correction in late 2018. Stocks went from way oversold, to way overbought. Supply needs demand, and demand had left the building. (James has the goods on the S&P 500's magic resistance line in our daily chart, below.)

Why it Matters

Timing is everything, as they say, but no one can actually time the market. After two historically strong months for stocks, the blueprint was in place for higher highs:

The Federal Reserve is being patient
Progress in the trade talks
Small cap stocks have been rallying (they usually lead the way)
March has been one of the strongest months of the year, going back 20 years

Those gains may come and we may hit higher highs, but nothing is guaranteed. What is true is that investors have been piling back into stocks over the past several weeks after deserting them at the end of 2018. This chart from EPFR, which tracks fund flows, shows a sudden surge in buying the week of February 19th.

Stock Buybacks are Back!

Share buybacks, which everyone seemed to love to hate last Fall, are back in a big way. In 2018, U.S. companies bought back $728 billion worth of their own stock as they found themselves with extra cash on their books thanks to the corporate tax cuts and higher profits. That was a 34% rise in buybacks from the previous year, which was also a record.

Companies buy back their shares when they think their stock is being undervalued, or they don't have a better use for their cash. Typically buybacks boost a companies' share price as supply is taken off the market. It can also be a sign to investors that management feels the shares should trade higher, so they should too.

In his annual letter to shareholders a couple weeks ago, Warren Buffett disclosed that Berkshire Hathaway had been buying back its shares and would continue to do so. He extolled the virtues of share repurchases, as he calls them, and gave the example of how Berkshire has benefited from share repurchases at American Express, its top equity holding. This is what he wrote:

"...Berkshire's holdings of American Express have remained unchanged over the past eight years. Meanwhile, our ownership increased from 12.6% to 17.9% because of repurchases made by the company. Last year, Berkshire's portion of the $6.9 billion earned by American Express was $1.2 billion, about 96% of the $1.3 billion we paid for our stake in the company. When earnings increase and shares outstanding decrease, owners – over time – usually do well." - Warren Buffett, February 29, 2019

Critics argue that buybacks benefit top shareholders and executives (who own a lot of shares), and companies should use the excess capital to pay higher wages to their non-executive employees, invest more in research and development, and invest in the future. You are going to be hearing a lot more of this argument as the 2020 election rolls around, trust me.

Politics aside, corporate executives are the stewards of their companies' capital, and if they see an opportunity to boost earnings and drive their stock higher, they will do it. They answer to shareholders.

They've been doing it a lot as of late. This chart, courtesy of Biryini and Associates and Bloomberg, shows just how popular the buyback bonanza has become. We'll get fresh data from companies and their buyback efforts in the next earnings season, which begins in early April.

Looking Ahead

As we keep saying, March is going to be an incredibly busy and important month for investors and the global economy. To that end, we've asked a few of our resident experts to write up guides to help you navigate the obstacles and understand how events and factors like Brexit, the trade war, oil prices and the dollar could move markets this month.

From James Chen, our resident market technician and investing educator:

5 Charts You Need to Pay Attention to in March.

From John Jagerson, one of our columnists and the author of our Chart Advisor newsletter:

The Investing Outlook for March

Chart of the Day: S&P 500 Halts at Major Resistance

Support and resistance are among the primary tools used by technical analysts to approximate market supply and demand levels for trading purposes. Support is considered a price "floor" where demand may begin to exceed supply, creating upward price pressure. And resistance is considered a price "ceiling" where supply may begin to exceed demand, creating downward price pressure. Of course, technical analysis is far from an exact science, and detractors may deem support and resistance levels as little more than simple coincidence.

But if we look at the S&P 500 (SPX), the most broadly used benchmark index, resistance around the 2816 level has been crystal clear. As shown on the chart above, the S&P 500 rose to around the 2816 level in October and November of last year before plunging both times. In early December, the index rose to just short of that resistance - around 2800 - before initiating the disastrous market plunge of December.

Fast forward to one week ago and then today, and the 2816 area has once again served as exceptionally solid resistance. On Monday, the S&P 500 rose slightly above 2816 before falling back sharply. Was there some fundamental factor that caused price to respect this resistance and subsequently retreat? Some analysts may say that skepticism over the prospects of a U.S.-China trade deal contributed to the fall. Perhaps more likely, though, this can be considered a technical sell-off, which is reasonable and expected given the very sharp trajectory of the market's rise over the past two months. Technical analysis attempts to identify just where these types of reversals or pullbacks may be likely to occur.

What may happen next for the S&P 500? If we stick with the support/resistance thesis, the 2816 level remains an upside barrier to further gains. But if the index is able to clear that barrier with a strong breakout, that could open the path back up towards September's 2940-area record highs. Alternatively, a continued down-move below the recently-cleared 200-day moving average could result in the type of volatile drops similar to what we saw in the fourth quarter of 2018.