THE BOTTOM LINE
In the days ahead the weight of the evidence is likely to shift in favor of a continuing bull market, or confirmation that an emerging bear market began at S&P-500 4818. Lowry Research calculates that Selling Pressure remains above Buying Power, and the gap between the two has been widening recently in favor of Selling Pressure, which has resulted in a Lowry sell signal. TATY has completed a “Big Chill” warning and is in position to perhaps issue another within a few days. The former caught the top to date, and if another is issued then it may identify the end of the first counter-trend rally in a new bear market.
Should the current rebound rally fail at, or below the previous S&P-500 uptrend support line, and then the spike low at S&P-500 4220 is violated on a closing basis, the probability of an accelerating decline, and/or a crash sequence developing is estimated at approximately 20% given the multiplicity of extreme and historic metrics at the S&P-500 4818 all-time high to date. On the contrary, if evidence favoring resurging demand over supply emerges, then the approximately 12% correction to date may have served to re-invigorate demand and put in place a renewed foundation for a new leg up in the ongoing great bull market.
Implied risks have risen to levels, which have compelled us to take defensive measures in client portfolios by reducing some of our exposure to equities. Investors should continue to expect higher than normal volatility resulting in potentially swift and violent price movements, both higher and lower. For those with the knowledge, training, experience, skill, analytical tools equal to the challenge, and the courage to apply them, a bear market can create opportunities to earn substantial profits faster than during slow plod along bull markets, which tend to stretch out over weeks, months and sometimes years. As one of my late friends and mentor once said: “This ain’t no place for amateurs”, and indeed it isn’t!
UNMASKING A MASTER OF DISGUISE
The stock market is a master at disguising what its next move may be, particularly when it comes to the formation of major tops. Major tops usually form after weeks, months, or in some cases years of seemingly endless shallow corrections followed by new all-time highs, but during which a nearly imperceptible decay process is slowly eroding the foundation supporting the bull market. Human beings are creatures of habit, so when bull markets just keep going investor behavior tends to become one of projecting the recent past into the future, which eventually becomes one of the component parts of the inevitable formation of a bear trap, just as the bull trend is finally surrendering to the cumulative effects of the long decay process.
Bear markets destroy wealth at remarkable speed relative to the snail’s pace at which bull markets create it, and the more extreme the metrics when the top arrives, often the more rapid the reversion to the mean tends to happen. In the current case, for those of you which remember your High School science, “average” extreme metrics at bull market tops are like the tight orbit of Mercury, the closest planet to our sun. The historic extremes at this potential major top are akin to a yet to be discovered planet orbiting way out beyond Pluto, the frozen small rock of a planet, which is furthest from our sun. When the next major top yields to the next bear market, you can imagine the potential for volatility and violent price movements as the emerging bear market gets down to the business of creating a counter-balance to the expiring great bull market. This is also known in certain disciplines in behavioral finance as “degree”, where a bull market is followed by a bear market of the same “degree”.
The balance of this update will examine the case for a continuing bull market after the current correction has run its course and formed a firmer foundation for another leg up in the great bull market. We will also outline the case for an emerging bear market, which has likely already completed the first leg down in the nascent bear trend. Correctly diagnosing a major top as it is forming is one of the greatest challenges for an analyst, and requires exceptional knowledge, training, experience, and market tools equal to the challenge, but at the end of the day it is still an exercise in putting the odds in the analyst’s favor.
TATY — A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown above in yellow with the S&P-500 overlaid in red and blue candle chart format. Having previously completed a “Big Chill” warning, TATY finished the week at 132 exiting the caution zone surrounding the 115-125 level and pressing the red zone surrounding the 140 level. If TATY continues to rally but then stalls out in, or near the red zone, then it will have issued consecutive back-to-back “Big Chill” warnings, which would be a bearish signal. TATY has a long and enviable record of identifying tops in bull trends and rebound tops in bear markets. If the price continues toward the broken previous S&P-500 uptrend support line shown in Screenshot-602 in red and TATY issues another “Big Chill” warning, then TATY likely may have identified both the latest major top as it was forming, and the rebound (lower) top after the completion of the first leg down in the emerging bear market.
On the contrary, if TATY continues to rally and begins to sustain itself with bottoms in, or near the red zone oscillating with tops forming near the blue zone surrounding the 160 level, then the recent 12% correction likely re-invigorated demand enough to sustain another new leg up in the ongoing great bull market. Please observe how the weeks long negative divergence in TATY (down sloping magenta line) foreshadowed the 12% decline, and how the positive divergence (green up sloping line) both in TATY and the Premium/Discount indicator in the lower panel also foreshadowed the current recovery rally, which began with a 1200 plus point Dow reversal off it’s spike low. This is exactly what this indicator was designed to do.
We need to watch TATY carefully for evidence of resurging demand, or more likely the development of another negative divergence. The former would suggest the 12% correction was sufficient to re-invigorate demand, or the latter, which would keep us on high alert for a new bear market just getting underway. The weight of the evidence has been trending toward the latter, as Lowry Research Selling Pressure has been surging while Buying Power has been fading. However, that Dow swift 1200 plus point reversal off the low demonstrated dramatically that the “buy the dips” crowd represents a still active and formidable bid under the market.
SAMMY — A REPRESENTATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS
SAMMY is shown in yellow with the S&P-500 eMini futures contract overlaid in red and blue candle chart format. Like TATY, SAMMY negatively diverged (dashed down sloping magenta line) with the all-time high price foreshowing the 12% decline, and positively diverged (up sloping dashed green line) as the first leg down was plunging into the S&P-500 4220-spike low. SAMMY’s lower low happened on a much more modest previous price decline, so the positive divergence tipped off the potential for a vigorous rebound rally, which has now happened.
The question of the moment is whether the fading rebound rally will generate another leg up after a brief pause, a leg up which may challenge the broken previous long term uptrend support line shown in red in S&P 500 Weekly (Displayed Below under Sterling). Broken uptrend support lines often, but not always, act as “attractors” for counter-trend rallies following completion of the initial leg down in new bear trends. How any further rally behaves should it approach that red broken uptrend support line may be critical in determining which we are dealing with, a continuing but fatigued bull or newly minted bear market. Obviously, a correct answer to that question has the potential to preserve wealth, and an incorrect answer could potentially result in a huge penalty for hard earned accumulated gains.
STERLING — A REPRESENTATIVE PROTYPE OF A FAMILY OF SHORT TO INTERMEDIATE TERM TRADING INDICATORS
STERLING is shown in daily format in the top panel with the S&P-500 eMini futures contract in the lower panel. This family of indicators tend to paint out an “island(s)” below the lower Bollinger Band as high probability trading bottoms are forming, and negative divergences as short to intermediate tops are forming. The green dashed up sloping line is an example of the former and the down sloping dashed magenta line an example of the latter. As the price marked time for five days before charging higher for three consecutive days, SAMMY was developing a positive divergence, which resulted in the rebound rally, which may have peaked Friday afternoon.
The STERLING family of indicators are testing well and may become critical tools for successfully taking advantage of trading opportunities created by the volatility inherent with fast moving bear markets. So, its development over a long period of time is coming to the end of testing at a critical moment, if we are now in a bear market. If the rebound rally continues toward the red broken former up trend support line, and STERLING gives us a big negative divergence just before the rebound rally expires, then that will be just the kind of performance I’m expecting from this new family of supply and demand indicators.
Above, respectively are the S&P-500 in daily and weekly candle chart format through Friday’s close. These show the all-time high and the subsequent correction to date. Given that broken uptrend support lines often act as “attractors” for the first rebound rally in a new bear market, I am watching the fading rebound rally to see, if after a brief pause it can generate enough strength to approach the red broken uptrend line. This would be an ideal place to further reduce our equity exposure, if a cohort of supply and demand indicators were displaying negative divergences as well. This may not happen, but the “buy the dips” crowd are not likely done just yet this close to the recent all-time high. In any case, we have already done some selling into strength as a precaution.
One last important observation, Screenshot-603 shows the S&P-500 in weekly format with the broken previous long term uptrend support line, which is now strong resistance for the rebound rally. If the recovery rally fails at, or near that new resistance line, then the stock market may become at peril of the institutions smelling a bear. When huge institutions with enormous resources collectively “recognize” they may be “over their skis” in terms of their equity exposure, then they may collectively hit the sell button just as they have in the past. This is how accelerating declines, or outright crashes happen in the stock market. If your stocks are in a popular tradable index at that moment, then the corporation’s franchise, its excellent management, its strong balance sheet, none of the fundamentals will matter, because the institutions are selling futures hands over fist and your stocks will go down with the indexes.
Screenshot-603 shows a crude drawing in dashed white lines of how an accelerating decline, or crash sequence may develop, if the first leg down in a new bear market is complete, and the current rebound rally is destined to fail, probably below the now red resistance line. The first significant chart support surrounds S&P-500 3200, and a crash sequence could get the market there faster than anyone wants to contemplate. I’d put about 60% odds on the emerging bear market case, and if that turns out to be correct, then I’d estimate about a 20% probability the new bear will experience at some early stage an accelerating decline and/or crash sequence with at least one 90% downside day, and likely more given the multiplicity of extreme and historic metrics, which developed during the bull market. Of course, all this is moot, if the weight of the evidence begins to shift in favor of a continuing bull market, well perhaps not moot, but rather just postponed until a bear of equal magnitude or “degree” as the expiring bull does materialize.