Election rally or overreaction?

Quick recap: last week

A week ago, the Kvarn Pulse newsletter was written in a cautiously optimistic mood. We saw signs that the S&P 500 index's decline of the previous weeks might be turning, which would draw a “higher low” in the index. We also noted that market breadth was strong and that the technology sector had strengthened slightly. Taken together, these factors gave us reason for cautious optimism, although plenty of question marks remained.

US elections move markets

Over the past week, the S&P 500 index has moved back and forth. Late last week, the index fell below 7,600 points, which briefly made the equity market look weaker than before. Once the results of the US midterm elections became clear, however, the index rose strongly on Wednesday and is again around its 50-day moving average.

The Nasdaq 100 index, on the other hand, looks clearly weaker. The index is currently quite far below its 10-, 20- and 50-day moving averages, and the outcome of the midterm elections did not materially change this.

The small-cap Russell 2000 index looks livelier than the other two. On Wednesday, the index rose above its 50-day moving average and is now encouragingly above all of its key moving averages.

One of the most striking features of the equity market in October was the weakness of the technology sector. This trend has continued over the past week. The ratio of the technology sector (XLK) to the rest of the S&P 500 (SPXT) has kept falling, and the ratio is already below its 200-day moving average.

The RPG/RPV ratio, which compares growth and value stocks, is also falling steeply. This ratio is already approaching the levels seen at the end of March, when the equity market was at the bottom of its correction at the time.

Anyone looking for encouraging signals in the equity market's internal dynamics might find them among consumer stocks. The ratio of consumer discretionary to consumer staples has turned clearly higher in recent weeks.

Market breadth has also improved further. Already more than 70 percent of S&P 500 stocks are above their own 50-day moving average.

The broad upward trend in the equity market is also visible in the equal-weighted S&P 500 index. The equal-weighted index has risen to new record highs.

Right now, it looks as though the technology sector remains quite weak, while almost the entire rest of the S&P 500 still looks very strong.

With these observations, the key question still seems to be: is the shift of capital from the technology sector to other sectors just a healthy rotation, or perhaps an early warning of an approaching correction?

After a remarkably strong Wednesday, we currently see slightly more signs pointing to the former. It is worth keeping firmly in mind, however, that this is only a one-day initial reaction to an election result that partly surprised many investors.

What matters is whether we see the equity market's positive momentum continue over the coming week, and whether the badly weakened technology sector starts to strengthen again.

Right now, the overall tone of the equity market remains strongly risk-off, which forces us to stay alert to the risk of a correction. At the moment, however, we see no signs that a correction is about to begin immediately.

The VIX index has fallen below its 200-day moving average, which points to easing investor nervousness now that the election result is known.

In the bond market, we also see the MOVE index turning lower.

As long as we do not see the VIX and MOVE indices move higher, we see no reason to expect an immediate correction. On the other hand, until we see the technology sector and growth stocks start to strengthen again, it seems unlikely that we will see significant index-level moves higher either. The coming week could therefore be a very interesting one in the equity market, as investors digest the election result and its expected effects.

Gold price bounced

One of the most interesting developments of the past week has been a sharp turn in the gold price. Last week, gold was still in a clear downtrend and had already dropped below $4,000. Since the US elections, we have seen a clear turn higher.

The move higher so far could of course be dismissed as just a “dead cat bounce” after a sharp fall. If the rally continues over the coming week, however, gold could soon start to show signs of an emerging uptrend. For example, a break above the 50-day average (about $4,200) would already be a quite promising sign.

The price of the other precious metal, silver, looks weaker for now. Until we see the silver price break above the $55 level, it is hard to see the recent move as anything other than a bounce within a continuing downtrend.

BTC back above $80,000

Last week, we noted that bitcoin's price action was starting to look fairly weak. The outcome of the US elections, however, appears to have brought some relief to the bitcoin price as well, and the price has risen back above $80,000.

The bitcoin price is currently right at its 20-day moving average. On the positive side, the price is above its 10-day moving average, but on the other hand it is still below its 50-day moving average.

In this kind of “limbo” between moving averages, drawing clear conclusions is quite difficult, and we think the best option is to wait for the price to move to the same side of its 10-, 20- and 50-day averages before drawing stronger conclusions about bitcoin's price action.

While the US election result appears to have given the bitcoin price a slight lift, the altcoin market does not seem to have reacted particularly positively. The ratio of the total altcoin market cap to bitcoin remains in a clear downtrend.

This points to caution among crypto investors. It is also in line with the equity market outlook: investors favour options perceived as lower-risk.

As with the equity market, our expectations for the crypto market would become considerably brighter if we saw investors once again start to favour higher-risk investments.

Summary

In summary, the results of the US midterm elections appear to have brought at least temporary relief to the equity market. Apart from the technology sector, the equity market looks quite strong, and it is entirely possible that the technology sector could also start to pick up and pull the equity indices into a clear uptrend.

It should be stressed, however, that Wednesday's market moves play a large part in the current reading. Before Wednesday, the equity market outlook looked outright weak. It is also worth remembering that one-off events such as election results are often followed by a temporary overreaction that can fade quickly.

The coming week could therefore be very informative. The next few days may already tell us whether the US midterm elections act as the trigger for a year-end rally, or whether the prevailing risk-off mood continues in an even more cautious form.

In addition to equity indices, we are closely watching the crypto market, and in particular whether the bitcoin price starts to follow the currently weak-looking tech stocks or gold, which has strengthened sharply in recent days.

Wherever the market goes, we will keep following the situation and keep you up to date, so stay tuned!