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Late in the trading day, the market rallied into the close after the White House announced an agreement with the European Union to “hold off on other tariffs” while trade negotiations move forward. The deal includes a pact to lower industrial tariffs and increase liquified natural gas (LNG) and soybean exports to Europe. While the deal doesn’t appear to immediately affect the steel and aluminum tariffs the administration imposed on the E.U. just a few months ago, Trump also said those tariffs would be addressed. Not surprisingly, the market reacted to the news enthusiastically; after spending most of the day up only slightly, the S&P 500 rallied almost 1% higher to finish the day. The close also marked a break above an important resistance level that has kept the market technically in correction territory since late January. Here’s a chart to illustrate.
The chart above applies to SPY, the SPDR ETF that mirrors the movement of the S&P 500 Index. From its all-time high on January 26 to its low point, the index moved about 11%; a move of at least 10% is generally considered a minimum requirement to classify a broad-based decline as a “correction.” In the same breath, in order for technical analysts to generally acknowledge the market has emerged from a correction, it will need to climb at least 10% from a correction’s low point. The market has approached the 10% level on three different occasions since finding a bottom in early February (and that was revisited in April), but as the chart demonstrates, repeatedly failed to move above it. Today’s close pushed the market above what is likely to be considered an important emotional signal of the market’s recovery from woes that have plagued the market throughout the year.
Is the worst over? Trade tensions have dominated news headlines since March, with every new rumor and Trump tweet stoking uncertainty more and more. And there is no doubt that the announcement signals an important positive step in repairing the relationship between the U.S. and one of its most important trade partners. It would be foolish, however to assume that all will proceed smoothly from this point forward. Questions about NAFTA, and the longstanding agreements it represents between the U.S., Mexico and Canada still remain, while China will surely remain the single greatest question that persists about the state of healthy global trade. Don’t be surprised if the confrontational nature of Trump diplomacy – and the tit-for-tat response that Trump’s targets have consistently given – continues to keep things interesting.
On the positive side of things, a step forward, and away from disaster will almost surely increase the hope that trade between the U.S. and all of its partners resume its normal course. The market abhors conflict, and loves the status quo, simply because that means that “business as usual” is the theme everybody gets to work from. And the status quo has generally been positive; corporate earnings through the current earnings season have come in better than expected in most cases, with economic reports continuing to validate the economy’s health and steady upward momentum.
How much upside does a break from correction territory provide? It’s an interesting challenge to try to predict how far the market could rise above an all-time high level. There isn’t one single way to do that, but one approach is to use the correction as a point of reference along with Fibonacci-based mathematics. The 1.272 and 1.618 Fibonacci numbers can act as a multiplier against the size of a market correction to estimate the size of a rally after the market has emerged from the correction. Using the market’s 10.8% correction as a starting point, and then multiplying that total size by 1.272 and 1.618 provides a range for where the top of the next major market rally could be. In the case of SPY, those calculations put its top-end resistance range between $323.03 and $333.65 per share. That’s between nearly 15% and a little over 17% above its current level – which should sound pretty exciting to any investor. Again, it isn’t a foregone conclusion, but it does suggest that if the U.S. and its allies can keep building from today’s positive news, the reward: risk proposition for investors could spur a completely new rally that could extend the long-term bull market even further along.