The trend in investor risk preferences remained negative throughout the recent market rally indicating negative market outcomes. You know the mood has turned when the markets respond negatively to what during the course of this bull market was considered good news.
The market advanced in anticipation of the Federal Reserve delaying lift off and then sold off on the actual news. In other words, once the expected market-lifting news was announced the markets had nothing to look forward to and reality set in.
The pattern we see in all the major indexes since the large “correction” looked like a continuation pattern. Initially it looked like a “pennant” but it formed into a “rising wedge” in the S&P 500. Both are continuation patterns with similar outcomes – in this case, continuation of the market’s decline.
Such patterns represent the psychology of buyers and sellers and have rational explanations beyond just descriptive shapes on the chart. But we will keep it simple and just say the market was taking a breather on its way to this correction’s final bottom. It also gives us pause since rising wedges often form during bear market rallies.
The candlestick chart of the SPY ETF that tracks the S&P 500 provides us each day’s price range. We also see the declining volume until the break out from the pattern. The breakout saw a surge in volume. This is a classic rising wedge pattern. Once it breaks the pattern, its expected decline is about the same as its initial decline (or the length of the staff). In other words, it is expected to establish a new low.
I am one to neither predict market bottoms nor try to trade them with today’s activist central bankers constantly wrestling with the “free” markets. But the odds of a repeat of the patterns seen in 2010 and 2011 as discussed in my September 4th post The Smart Bird: Counting the Days Part II just increased. In both cases the market’s initial correction lows were taken out. In the three corrections, the S&P 500 index went on to lose between 7 – 10% off the post-correction highs.
In the same post, I recommended 16 September would be a good day to reduce exposure if one was still heavily exposed to stocks. This was based on the Fed’s announcement on the 17th and since I felt the 16th would better correspond to post correction peak. As it turns out, it was the peak and while I am patting myself on the back I will admit that my main worry was that the Federal Reserve would do the right thing and raise rates. They held rates steady, yet the markets still declined and appear to be playing out the pattern. I never expected a large rally, but the lack of any rally is telling.
Since a classic continuation pattern occurs half way through a market’s move that would roughly translate into the S&P 500 hitting at least 1850 – 1800 or 7 – 11% off the post correction high similar to the other three corrections. A move to 1800 would be 15% off the market’s all-time high. Some technical analyst place the target at 1730 which is 19% below the market’s all-time high. It’s possible.
TSP Smart Investor has been out of stocks since May and providing additional warnings about the deteriorating conditions all summer. I can see why some analyst might have held to their bullish bias into late May, but by early August I just did not see any support for the bullish position based on market action. None. Other than those who believe the Federal Reserve actually knows what they are doing or can actually prop the markets up indefinitely. This belief requires ignoring market history.
I realize the US economy is not indicating recession. While I often repeat the stock market is a leading indicator of the economy and not the other way around, I will go one step further. The economy does not matter and never has during this bull market other than to give the Federal Reserve an excuse to provide the financial sphere what it wants. It is the turning of the global credit bubble that is driving the market outcome and the economy will follow at some point.
The Fed delayed hiking due to what it sees occurring in the financial sphere not the economic sphere. Now is the time to focus on what really matters and stop listening to the market cheerleaders. Check and see how your financial advisor did in 2008, not just during the bull market. It’s your retirement, not theirs.
And above all… invest smart.