Slow Rollover Gives Way to Fast Decline

 |  Includes: DIA, IVV, QQQ, SPY, VOO
by: Roger Nusbaum

A couple of weeks ago a reader asked a question about the 2% rule, which is a way of isolating a slow rollover (2% decline three months in a row). We took some defensive action when the S&P 500 breached its 200 DMA (at the time I joked that if it kept going down we should have taken more defensive action and if it turned around we took too much defensive action). I also mentioned that I think two sub 2% GDP prints means we are headed into a recession sooner than most experts think.

The above makes an argument for a bear market in the weeks and months ahead. Now current events have turned a slow rollover into a fast decline. This potentially changes a couple of things. I offer this up not as a prediction but more as a potential what if and preparing a strategy.

The nature of fast declines is that they retrace a large portion of the decline quickly. This is not a Jim Paulsen-like bullish argument, just an observation from past panics (click chart to enlarge). I'm not concerned with trying to be correct so much as have something in mind if a retracement comes quickly. Animal caricatures aside I think the S&P 500 is going to be below its 200 DMA for a while. Currently the 200 DMA is at 1286, or about 150 points away. This makes an argument for being oversold and contributes to the argument for a retracement.

If there is a meaningful retracement, or as I have referred to this before as a feel good rally, I would expect it to stop well short of the 200 DMA. I think I see a possibility of a snapback taking it to 1210-1220 but that might be wrong and wishful thinking but the idea of a feel good rally seems very plausible.

I would take more defensive action if I thought a snapback was starting to tire out. Again I do not think the 200 DMA can be taken back anytime soon but there can still be a string of big up days in a bear market. It makes sense to think about this now, decide whether action for your portfolio is suitable in this context and if so think about what you would do.

Given that this is a panic for now (I believe it is anyway), I certainly don't know when it will end but there have been panics in past bear markets that are followed by feel good rallies which makes any meaningful selling on a day like Monday a bad idea based on how these usually play out.