Revisiting The Signals That Forecasted Every Major Downturn Since The 2018 Volatility Shock: What's Next

Summary

• Members of my service were alerted last Friday morning that the Momentum Gauges turned negative for the first time since Sep 2019.
• This article highlights three reliable signals that have forecasted every major market decline since the VIX volatility event called "Volmageddon" at the start of 2018.
• The inverse signals initiated the buy signal on October 15th that preceded gains of over 10% in the S&P 500, +93.9% in FNGU, +49.9% in TQQQ, and +31.9% in SPXL.
• The new signal change impacts the 12 different Bull/Bear ETF combination trades used to leverage market direction changes for maximum returns.
• This article revisits each of the prior forecast events and illustrates likely short-term outcomes to the signal on Friday, January 24th.
• This idea was discussed in more depth with members of my private investing community, Value & Momentum Breakouts. Get started today »

Introduction

This article examines the current breakdown signal against the 3 measures that forecasted every major downturn since Volmageddon in my previous analysis in August of 2019. Two of the measures have turned negative and one of the measures remains unchanged since July 2019. I will review the four most recent downturn events and address the current breakdown signal from the Momentum Gauges on Friday, January 24th.

Historically, there have been a total of 5 prior Momentum Gauge event signals as shown on the long-term weekly chart above.

Event number 1 on the chart was not a forecasted event but was confirmed by the multiple discriminant analysis (MDA) values of my model while we experienced the 2018 "Volmageddon" event. This first event was so unique and significant that it prompted me to use the Momentum Gauge model on a more frequent basis. I now run the model not only weekly but multiple times intraday for members of my service. It was also a key volatility event that brought into close focus the impact of the new Federal Reserve quantitative tightening (QT) policies that began implementation in January 2018. As an update to my article last year, I will revisit these conditions as the 6th event begins.

Forecasted Events of the Momentum Gauge Signals

To date, there have been four forecasted events using the criteria that compose the model derived from my doctoral research on the price momentum anomaly and reversal event signals. Each of these four signaled events will be looked at again briefly with reference to prior published articles in a process to consider the strength of the most recent Momentum Gauge topping signal last Friday.

The three indicators applied to each of these forecasted events with high reliability are:1. The Momentum Gauge scores turning negative intraday, daily, and then on the weekly chart.2. The leveraged FANG+ Index funds in strong technical MDA breakout/breakdown conditions as proxied by the MicroSectors FANG+ Index 3X/-3X Leveraged ETNs (FNGU) and (FNGD)

3. Increased Federal Reserve actions toward quantitative tightening or the lack of any accommodative policies relating to easing liquidity to the markets.

3b. Directly related to this liquidity or the increased accommodative policies by the Fed is the enormous volume of corporate buybacks fueled by less expensive debt from lower interest rates. As I have detailed in prior articles, one analyst calculated that:

since the beginning of 2011, the S&P 500 would have been 19% lower than it is today if no buybacks were performed at all.

While corporate buybacks are continuing at all-time record highs, the executive insiders are selling at much higher rates to preserve their gains. This ratio chart of Number of Corporate Insider Buy:Sell from 2015 to 2020 shows how high levels of insider selling and low levels of buying have preceded market downturns. Conversely, high insider buying relative to selling precedes strong market upturns. We are in another period with higher selling than buying and with insider buying at or near all-time lows in the past 5 years.

Reviewing the Four Prior Forecasted Market Top Signals

Market Top Signal 1:

The first forecasted signal occurred in Week 39 of September 2018, as shown above, had many validating indicators that forecasted a strong market decline. Key among these factors was the start of the Fed's quantitative tightening program called by the Fed the balance sheet normalization policy.

The VIX volatility index chart above recaps how the start of the QT policy may have contributed to the liquidity shock of January 2018. Then, the volatility index stabilized until the liquidity tightening jumped to the maximum monthly level of the Fed policy at the start of October.

As the related articles document, this event corresponded with: 1) Momentum Gauges turning negative, 2) the Federal Reserve draining liquidity at the policy maximum rate of $50 billion per month, 3) The 10 largest market cap stocks from the FANG+ index all in strong technical MDA breakdown conditions. The related charts and conditions are chronicled in the links below:

• 8 Warning Signals Of Deteriorating Market Conditions
• Profiting With Volatility Gains As The Fed Drains
• Monitoring The Market Tipping Point (Member article)

Market Top Signal 2:

The second signal occurred in the first week of May 2019 and was validated by the same three indicators again. Again, in this 2nd signal: 1) Momentum Gauges turning negative, 2) the Federal Reserve continued draining liquidity as shown on the Weekly Momentum Gauge chart below, and 3) The 10 largest market cap stocks from the FANG+ index were all in strong technical breakdown conditions.

• Momentum Gauge Signals Most Negative Since The October Correction (Member article)

The Weekly Momentum Gauge chart below shows a red circle on Week 18 representing the largest Federal Reserve asset roll off (tightening) event for 2019 and even back earlier to 2018. The black arrow shows the S&P 500 decline on the yellow line for this event in May 2019.

Market Top Signal 3:

The third signal occurred in the first week of August 2019 and again was forecasted by the Momentum Gauges that preceded a multi-week market decline. The event corresponded with President Trump announcing more increases in tariffs on Chinese goods ahead of expected talks in Sep/Oct time frame.

The daily chart above of the Momentum Gauges Signals the negative blue line crossing above the positive green line. The more detailed articles of these events are linked below from the Friday to Monday signal.

• V&M Breakout Morning Update - Aug 2: Momentum Gauges Turn Negative (Member article)
• V&M Breakout Morning Update - Aug 5: Market Breakdown Signal (Member article)

Again, in this 3rd signal of August 2019: 1) Momentum Gauges turned negative, 2) the Federal Reserve continued draining liquidity in what they called "organic tightening," but had just announced the end of the Quantitative Tightening policy on July 31st, and 3) The 10 largest market cap stocks from the FANG+ index were all in strong technical breakdown conditions as proxied by the FNGU ETN.

Market Top Signal 4:

The fourth signal occurred in the later part of September 2019 and again was forecasted by the Momentum Gauges that preceded a multi-week market decline. The chart below with the Fibonacci retracement levels showed how the decline began on Sep 24th and found support for positive reversal a few weeks later.

Again in this 4th forecasted signal we revisit the indicators: 1) Momentum Gauges turned negative, 2) the Federal Reserve had stopped draining liquidity and was beginning some "organic easing" as shown on the weekly charts, 3) The 10 largest market cap stocks from the FANG+ index turned to strong technical breakdown condition as proxied by the bear fund FNGD.

• Momentum Gauge Intraday Cross To Negative Market Conditions (Member article)

The Current Momentum Gauges Breakdown Signal

The current breakdown signal, or market top signal 5, occurred last Friday on January 24th, 2020 as shown in the chart below. Members received morning notifications Friday and were able to prepare for the over 450-point drop in the DJIA on Monday. But is this event over? Let us examine the key indicators for some additional insight.

Moving through the checklist of indicators we have the following:

1. The Momentum Gauge scores turned negative intraday, daily, and have begun to go negative on the weekly chart through Tuesday as well. The long-term daily chart below shows how long each of the prior negative events has lasted and highlights in blue the typical high/low range of the negative momentum scores during these events. Currently, the negative score is at the lower range of the band.

2. The leveraged FANG+ Index funds were in strong technical MDA breakdown conditions as proxied by the MicroSectors FANG+ Index -3X Leveraged ETN (FNGD) and showed an initially strong negative breakout along with the VIX volatility fund (TVIX). These indicators provide an early detection of volatility and high net fund flows out of the largest market cap stocks.

What may be different this time is that while these 10 largest FANG+ stocks showed a significant drop from high valuation levels, Apple (AAPL) announced very strong earnings after hours that may push this index and the larger DJIA and S&P 500 indexes higher despite the other market warning factors. Strong iPhone sales drive Apple beat; shares +2.4%

On the Weekly Momentum Gauge chart with a partial update through Tuesday of the current Week 5 we see the following:

The current Weekly Chart of the Momentum Gauges shows the negative momentum crossing above the positive momentum line for a negative weekly signal further confirming indicator 1. 3. The blue bar chart at the bottom of the chart above shows the Fed's weekly "organic easing" amounts as disclosed last week to be $12.7 billion. In 13 of the past 14 weeks, the Fed has maintained an easing approach toward the market that should be favorable toward or help mitigate the magnitude of these downturn events.

In summary, the Momentum Gauges turned negative and are beginning to confirm negative conditions on the weekly chart.

Working against these signals in this event: 1) the Federal Reserve continues to add liquidity through an "organic easing" process, 2) AAPL the largest of the FANG stocks has reported blow out Q4 earnings after hours, 3) We await the Federal Reserve's FOMC decision for Jan 29th. All of these factors could undermine the negative signal and it will be important to consider these factors through the week.

What Could We Expect Next?

Depending on the strength of these factors in the current downturn event we could see a continuation of the same patterns as before. Each of the prior event signals lasted more than two weeks and in the case of the October 2018 decline, it lasted over 11 weeks including 3 positively gaining weeks. Each of the prior downturns tested the 40-week moving average of the weekly chart shown below or the 50-day moving average in a daily chart. In the case of October 2018, the three factors were so adverse that it broke below support to the 200 weekly average red line in the chart.

Presently, we have seen an initial volatility spike as measured by the VelocityShares Daily 2x VIX Short-Term ETN (TVIX) that gained over 20% Monday and also signaled all other prior events and continued higher for several days.

We should continue to watch these indicators for additional market topping signals that could mark another decline to the 50- or 200-day moving average on the chart below:

Conclusion

The S&P 500 chart above shows how the overbought RSI levels may also be signaling a market top just as the Momentum Gauges cautioned this past Friday and for the past 3 consecutive days. It will be telling to see if the accommodative Fed policy combined with strong AAPL results can buoy the markets through what would ordinarily be another reliable downturn signal of the momentum gauges.

We can learn more as events transpire that help add to the data being collected for these signals and for the methodology to improve forecasting accuracy. I hope you found this information beneficial to your trading and I wish you all the very best in your trades!

All the very best to you and have a great week of trading!

JD Henning, PhD, MBA, CFE, CAMS

Disclosure: I am/we are long FNGD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.