Sentiment Speaks: Are We Setting Up For A Market Crash?

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Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: Avi Gilburt
Summary

The market made a lower low early this week, as per my last article.

The market has now transitioned to a very bearish posture.

As long as resistance holds, a break of cited support will open the door to a waterfall decline.

It is not often that I will write a second article about the stock market in a single week, but I think it to be warranted at this time.

For those that were following me last year, you would know that the break down below the 2880SPX region in the fall had me alerting our members of a potential 20-30% correction. And, when the market dropped into the 2250-2335SPX region, it had me alerting them to a bottoming in the market, followed by a bigger degree rally to at least the 2800SPX region.

Currently, we have again broken that same signal level at the 2880SPX region, of which I warned several weeks ago. And, the structure we are seeing in the market is presenting the same type of set up as we saw back in the fall of 2018.

I want to remind you that my analysis is based upon the premise that markets are driven my human sentiment and are, therefore, fractal in nature. That means they are variably self-similar at different degrees of trend. And, being such, patterns often repeat in the market, and are not necessarily driven by the substance of any news event.

For those that question this premise, consider what Bernard Baruch noted many years ago:

All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking ... our theories of economics leave much to be desired. ... It has always seemed to me that the periodic madness which afflicts mankind must reflect some deeply rooted trait in human nature — a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea ... It is a force wholly impalpable ... yet, knowledge of it is necessary to right judgments on passing events.

Moreover, during his tenure as chairman of the Federal Reserve, Alan Greenspan testified many times before various committees of Congress. In front of the Joint Economic Committee, Green- span noted that markets are driven by “human psychology” and “waves of optimism and pessimism.”

In fact, Mr. Greenspan went so far as to note:

The cause of economic despair, however, is human nature’s propensity to sway from fear to euphoria and back, a condition that no economic paradigm has proved capable of suppressing without severe hardship. Regulation, the alleged effective solution to today’s crisis, has never been able to eliminate history’s crises.

Ultimately, as Greenspan correctly recognized, it is market sentiment that determines market trends. In fact, even the news events of the day are interpreted based upon the prevailing market sentiment. That is why we often see markets rally despite bad news being announced, and explains why markets fall despite good news being announced. So, underlying market sentiment is what I attempt to analyze and I utilize Elliott Wave analysis for this endeavor.

As I have also noted many times in the past, studies have been performed over the last 20-30 years which have come to support this overall perspective about market sentiment being endogenous, rather than being affected by exogenous events in the manner in which many believe.

For example, in a paper entitled “Large Financial Crashes,” published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation for the overall herding phenomena within financial markets:

Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an “emergent” behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.

To this end, you may also want to consider the following study. In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.

This means that a news event can act as a catalyst to a market movement, but the substance of that news event will not always be instructive as to the direction of the market move. The best recent example I can give you is that during the heart of the trade wars in 2018, the stock market rallied 9%. Yet, today, the market is now declining during trade war news. While I am sure many of you will attempt to explain why the market can rally and decline during trade war news, those of you who are intellectually honest about this will clearly see through that, and understand why the study cited above presents the clearer reasoning as to why we have seen these differing movements in the market based upon the same type of news.

Now, let’s get to the point of this update. With the market providing us a lower low early in the week, it has placed us in a very bearish posture. In fact, if the market drops directly below its next support of 2760/85SPX, then 2810SPX becomes resistance, and the door opens for a waterfall decline which can see hundreds of points shaved off the market and quite quickly.

So, while I have to leave the specifics of this set up to the members of The Market Pinball Wizard, I wanted to at least alert those who follow my work to this potential. While the market can still provide us more upside consolidation before this potential drop takes hold, I wanted to at least warn you of the immediate potential for this to occur earlier than I had initially expected. And, as long as any upside consolidation holds resistance below 2880-2920SPX, this set up will remain as my primary expectation.

HOUSEKEEPING MATTER

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.