I have updated the attached charts through Friday’s close, but of course the Fibonacci retracement levels shown have not changed as the budding rally has gained strength, which further reduces the chance that the December 24 crash type low will be retested. So now it is time to cheer the resurgent bull market, which was left for dead only a few days ago right? Well not so fast, as the multiplicity of ways a bear market may develop would suggest a more step by step approach, confirmed all along the way by hard numbers generated by the market itself, before making such bold and unhedged statements.
This past week’s strong rally only increased the probabilities that one of the paths mentioned may eventually turn out to be the way the market chooses to develop going forward. However, the most probable does not mean these are the only paths available for the market. The multiplicity of ways a larger bear market may develop represents substantial opportunities for traders, but a literal nightmare of a challenge for researchers and analysts to correctly diagnose in real time, as crucially important as that may be.
I am going to update the options outlined in last week’s update, and then tell our clients specifically how we will deal with each option, as the market hands out more clues about its further development. Let’s begin with the probability of a retest of the December 24 low, which was the subject of a research piece by a firm in NYC mentioned last week. My response to my friend and former colleague, which sent me the piece, was to suggest that such a simplistic notion would seem to have a low probability of happening given the three consecutive 80% downside days culminating in the December 24 crash type low, which was followed by evidence of resurgent demand on December 26, which in turn resulted in a record for a one day Dow point gain. And, please remember TATY also took a rare intraday excursion to 101 during the tempest of December 24. Since the 1990s TATY has only touched into the green zone surrounding the 90-100 level ten times, and all ten times the S&P-500 went on to touch new all-time highs, albeit sometimes after a retest of the low. So the intraday spike to 101, only one point shy of the green zone, would tend to support the case that December 24 was at least a short term low, and likely something even more significant.
The events of this past week would only appear to diminish the probability of a retest of the December 24 low even more, which no doubt is frustrating to those posturing to buy the retest. So to summarize this section, the probability of a retest of the December 24 low was not significant last week, and is even less now after the strong rally of this past week. However, please note that a low probability is not a zero probability. Even if a retest does develop, as long as the retest occurs with strong positive divergences in place among supply and demand indicators, then I would use the retest as an opportunity to put excess cash to work.
The shrinking probability of a retest means the bear market ended on December 24, and the resurging bull is ready to resume his bull run right? The first chart above shows the calculations for the most frequent Fibonacci retracements applied to the rally from the February 2016 low to the all-time S&P-500 high at 2941. The bear managed to clock a 20% decline from the high to the intraday low, which translated into an approximate 50% retracement of the entire rally leg dating to February 2016, which is well within the kinds of numbers expected for correcting the excesses built up during that leg of rally. So yes there is some objective market generated evidence that the bear market may be complete, and a new bull leg has begun. However, if this is the path the market does eventually choose, then supply and demand indicators must confirm every step in the process ahead by painting out higher highs and higher lows not only in the price, but in a series of indicators as well.
As long as the rally in price continues to be confirmed by increasing strength in the supply and demand based indicators, then we just go with the developing bull trend. Remember, last week’s update said that our clients were already invested, so if the market did not serve up the retest of the December 24 low as postulated by the NYC research firm, then we were still golden. So to summarize this section, we stay long our current positions, many of which will soon qualify for long term capital gains treatment, as long as the price rally continues to be confirmed by growing strength in the indicators.
Well now that is all fine and good, but what is this business about “Or An Insidious And Dangerous Bear Trap” mentioned in today’s header of the weekly update? I’ve mentioned “multiplicity of paths available to bear markets” several times for a reason. Bear markets have a long history of fooling investors over and over until they are eventually sucked into a vortex of violence, which occurs as the bear approaches a climatic panic driven end, where mindless program and panic selling become the order of the day. Yes there was a whiff of panic on December 24, but not on the order of magnitude normally associated with a major bear market bottom.
Please take a look at the second chart above, which calculates the most common Fibonacci retracement levels applied to the rally from the March 2009 low at S&P-500 666 to the all-time high at 2941. I would submit to clients that a bear market on this scale, or degree if you will, would likely generate an ending sequence attendant with the panic and mindless program selling normally encountered during the “recognition” phase, or vortex phase of major bear markets, as multitudes of global investors stampede to exit through a small door all at the same time.
I do not do predictions, as I leave that exercise in futility and frustration to those, which hold themselves out as having that particular gift. However, as a matter of due diligence for clients, I always include an assessment of probabilities concerning the worst case scenario. At the moment, the worst case just described above has a relatively low probability, but a significant enough probability to put Alexander and I on guard for any shift in the probabilities from lower toward higher for this potential bear path. All clients, especially those over age 50, must be protected from a bear event of this potential degree and potential for wealth destruction.
Now for the good news. Unlike the vast majority of financial advisors, and legions of insurance sales people trying to pick up some extra revenue masquerading as financial advisors, we actually have the experience, tools and courage of conviction to navigate any of the paths outlined above. No not with opinions about earnings, Brexit, impeachment, China tariffs, or countless other global factors impacting aggregate supply and demand for stocks, but rather armed with market generated objective information related to the ever changing balance of supply and demand for stocks, which is the ultimate driver of the price regardless of the reasons assigned after the fact!
The bottom line for this week is the balance of supply and demand, as measured by a series of objective indicators, is growing stronger after signs of a cathartic type bottom on December 24. So for now we ride the developing bull trend, and monitor it carefully for increasing strength, or creeping weakness. Last week’s update showed TATY finished the week at 141, and on Friday it finished at 146 (see last attached chart), which is above the red zone. A series of higher highs and higher lows in this indicator would be a sign of diminishing risks, especially if the indicator can touch high numbers in the 150 to lower 160 range, while bottoming above, or near, the red zone. Failure to generate these kinds of numbers in the weeks ahead would likely begin to raise the probability that a larger degree bear was still in effect, even if the price achieved new all-time highs. The word for the days and weeks ahead is “vigilance”!
My apologies for the length of this update, but the “multiplicity of paths available to bear markets” demand a more robust explanation for clients to understand what we are doing with their wealth and why. Just how it is when dealing with bear markets.
TATY, a supply and demand indicator, is shown in yellow on the attached chart, and the S&P-500 is shown in red and blue candle chart format.
Senior Portfolio Manager