The stock market has arrived at an important juncture, so this weekend’s update will cover more detail than usual. Alexander and I always want clients to be fully briefed, so I will do my best to keep this update at a level that non-professional investors can understand.
During my post-up recover from back surgery, I received an email from a close friend and former colleague. It had attached a research report from a firm in NYC, which laid out the case that since the market experienced a very negative trading shortened day on Christmas Eve, a retest of that Christmas Eve low would almost surely follow. My former colleague asked me to comment on the research piece, so I told him to beware of such a simplistic observations, as the market may be setting up for a more complex and insidious outcome.
Let us cover some basics, and then try to put the current situation into a stream of probabilities. A bull trend is the most easy to identify in market analysis, because the generally accepted definition is that bull markets move in a series of higher highs and higher lows. Some disciplines get more sophisticated and add non-overlapping rules, but for our teaching purposes today we shall keep it simple and stick with the higher highs and higher lows definition. Now this is where it gets more complicated, because bear markets can develop into multiple forms of overlapping movements, and to make matters worse one complete series of overlapping movements can connect to another making for an even more complex bear market when complete. So a bear trend may be simple or quite complex, and the analyst has no way of knowing early on, which kind of bear the market may dial up, or the duration. While bear markets may be wonderful environments for traders, they are often extreme challenges for researchers and analysts due to the multiple ways in which they may develop.
The evening news you are listening to very likely is referring to the stock market being in a bear market, and by one generally accepted definition the market has intra-day touched the required 20% down off the all-time high to qualify as a bear market. So here is the rub, is the bear market complete as of the December 24 low, or are investors caught in the beginning of a larger and much more complex developing bear market? In a former update I quoted Churchill’s famous observation during WWII that “This maybe the end of the beginning”. In this analogy the intraday low on December may have been the end of the beginning, or it may have been the end of the entire bear?
In Lowry Research analysis there were three consecutive 80% down side days culminating in the December 24 low. Then on December 26 the stock market erupted higher to set a one day point gain record for the Dow. This in the Lowry discipline constituted a reversal of the short term trend from down to up. While there may very well be a retest of that intraday low of December 24, the odds would have appeared to have shifted in favor of the bulls. TATY, a supply and demand indicator, also spiked intraday on December 24 down to 101, a rare event. There have only been 10 times since the 1990s that TATY has descended into the green zone surrounding the 90-100 level. In all ten cases new all-time highs followed, albeit on some occasions after a retest of the low. Does the one point miss at 101 on December 24 signal that another assault on new all-time highs is probable? So the notion according to the NYC research firm that a retest of the low is almost a sure thing could be right, but the notion that the bottom of a complete bear is in, or only the first leg down in a more complex bear is complete may be just as probable?
Just in case the walk through above is a bit confusing to you, I want to add some more perspective to what is actually happening, and then focus on what must happen to narrow these probabilities down to a tactical plan within a larger strategic outlook. To do this we need the help of a 12th century Italian mathematician named Leonardo Fibonacci. Fibonacci discovered a number sequence and series of ratios, which occur repeatedly in nature, and interestingly enough the markets. It is beyond the scope of this brief update to delve deeply into the application of Fibonacci’s work to the stock market, so we will just say declines in bear markets more often than not tend to stop at a Fibonacci retracement level. Currently there are two propositions being put forward about the current bear market. The first is that it is correcting the rise since the low in February 2016, and the other is that a huge bear market is underway correcting the entire bull trend, since the March 9, 2009 low at S&P-500 666 to the recent all-time high at 2941. While either degree of bear trend would inflict serious pain on investors, the latter would be devastating to those over age 50. So which portion of the bull trend is being corrected is more than an academic exercise. As an aside, before you look askance upon Fibonacci, please be informed that in all races and cultures, those having features in symmetrical Fibonacci proportion are thought to be “beautiful”. The Mona Lisa, for example, displays these proportions. There are even plastic surgeons these days, which use Fibonacci masks to aid in their reconstruction work.
The first chart above shows the three most common Fibonacci retracements of 38%, 50% and 62% applied to the bull trend beginning in February 2016 to the all-time high at S&P-500 2941. The current decline has already touched the 50% level, and given the Lowry Research discipline outlook for a reversal, and the rare TATY intra-day decline to 101, a case can be made that the bottom may in, or according to the NYC research outfit may be in on a retest of the December 24 low. My clients are already invested, so if the re-test does not happen we are already golden.
The second chart above shows the application of the three most frequent Fibonacci retracements applied to the bull trend from S&P-500 666 to 2941 beginning at the March 9, 2009 low. The minimum expected 38% retracement would carry to S&P-500 2072, and a 50% retracement would take investors to the March 9, 2009 low at S&P-500 1804, or the total loss of the last 14 years of accumulated gains! So the degree of the bear market one is dealing with really matters in terms of accumulated wealth. The good news is the opportunities created by bear trends on a scale equivalent to correcting the excesses accumulated during the bull run from February 2016, or March 2009 will be substantial, even as the average buy and hold investor stranded in chronically underperforming annuities and/or high commission mutual funds are pummeled by what the weight of the evidence continues to tilt toward a larger and much more complex bear market being underway.
So here is the bottom line as it pertains to preservation of your wealth, and the enhancement of your wealth with the least risks possible. The probabilities are drifting more and more in favor of the onset of a large and complex bear market. The first leg down in this new bear market has thrown off objective evidence on December 24 and 26 that this first movement down may have ended, or will likely end on a retest of the December 24 low. A lesser probability is that a bear market is complete at the December 24 low, and the resumption of the larger bull trend is at hand. If there is going to be a retest of the December 24 low, then the supply and demand indicator, TATY, will likely falter and stall in, or near, the red zone surrounding the 140 level. Please notice it ended the week at 141, see third chart above. If there is a retest of the low with supply and demand indicators painting out strong positive divergences, then I will use those conditions to put excess cash to work in anticipation of a substantial rebound rally to follow.
On the contrary, if there is no retest of the December 24 low, then TATY will likely begin to paint out objective numbers above the red zone surrounding the 140 level, and pullbacks will continue to form higher and higher lows vis-à-vis the indicator. If the low is in, then TATY must continue to strengthen. Please note that in a huge complex bear trend a new all-time high could occur in advance of a relentless and devastating final leg plunge down as the big bear trend entered its recognition phase where mindless program and panic selling become the order of the day. This setup could occur even if the degree of bear is only correcting the rise from February 2016, or for sure from the March 2009 low at S&P-500 666. Obviously the difference in “degree” at work could devastate investor wealth. On the other hand, properly navigated, investor wealth could be enhanced substantially by adroit trading guided by supply and demand indicators taking advantage of rare and fleeting discounts to “value”.
The weeks and months ahead are pregnant with opportunity, but unfortunately not for the vast majority of money managers, which lack both the tools, skill and courage required to navigate a big, complex, and violent bear market.
My sincere thanks to all doctors and nurses at Archbold Hospital for their care and skill, while repairing my chronic back injury of long standing. I’m making steady progress with my recovery.