Technically Speaking: Sellable Rally, Or The Return Of The Bull?
Summary
- As expected, the market rallied hard on Monday on hopes that the Federal Reserve, and Central Banks globally, will intervene with a "shot of liquidity" to cure the market's "COVID-19" infection.
- While the volume of the rally on Monday was not as large as Friday's sell-off, it was a solid day nonetheless and confirmed the conviction of buyers.
- It is absolutely "possible" the markets could find a reason to rally back to all-time highs and continue the bullish trend.
Typically, "Technically Speaking," is an analysis of Monday's market action, and the relevant risk/reward dynamics for investors. However, this week, we need to update the strategy we laid out in this past weekend's newsletter, "Market Crash & Navigating What Happens Next."
Specifically, we broke down the market into three specific time frames looking at the short, intermediate, and long-term technical backdrop of the markets. In that analysis, our premise was a "reflexive bounce" in the markets, and what to do during the process of that move. To wit:
"On a daily basis, the market is back to a level of oversold (top panel) rarely seen from a historical perspective. Furthermore, the rapid decline this week took the markets 5-standard deviations below the 50-dma."
Chart updated through Monday.
"To put this into some perspective, prices tend to exist within a 2-standard deviation range above and below the 50-dma. The top or bottom of that range constitutes 95.45% of ALL POSSIBLE price movements within a given period.
A 5-standard deviation event equates to 99.9999% of all potential price movement in a given direction.
This is the equivalent of taking a rubber band and stretching it to its absolute maximum."
Importantly, like a rubber band, this suggests the market "snap back" could be fairly substantial, and should be used to reduce equity risk, raise cash, and add hedges."
Importantly, read that last sentence again.
The current belief is the "virus" is limited in scope, and once the spread is contained, the markets will immediately bounce back in a "V-shaped" recovery. Much of this analysis is based on assumptions that "COVID-19" is like "SARS" in 2003, which had a very limited impact on the markets.
However, this is likely a mistake as there is a very important difference between COVID-19 and SARS, as I noted previously:
"Currently, the more prominent comparison is how the market performed following the 'SARS' outbreak in 2003, as it also was a member of the 'corona virus' family. Clearly, if you just remained invested, there was a quick recovery from the market impact, and the bull market resumed. At least it seems that way."
"While the chart is not intentionally deceiving, it hides a very important fact about the market decline and the potential impact of the SARS virus. Let's expand the time frame of the chart to get a better understanding."
"Following a nearly 50% decline in asset prices, a mean-reversion in valuations, and an economic recession ending, the impact of the SARS virus was negligible given the bulk of the 'risk' was already removed from asset prices and economic growth. Today's economic environment could not be more opposed."
This was also a point noted by the WSJ on Monday:
"Unlike today, the S&P 500 ETF (SPY) spent about a year below its 200-day moving average (dot-com crash) prior to the SARS 2003 outbreak. Price action is much different now. SPY was well above its 200-day moving average before the coronavirus outbreak, leaving plenty of room for profit-taking."
Importantly, the concern we have in the intermediate term is not "people getting sick." We currently have the "flu" in the U.S., which, according to the CDC, has affected 32-45 million people and has already resulted in 18-46,000 deaths.
Clearly, the "flu" is a much bigger problem than COVID-19 in terms of the number of people getting sick. The difference, however, is that during "flu season," we don't shut down airports, shipping, manufacturing, schools, etc. The negative impact on exports and imports, business investment, and potential consumer spending are all direct inputs into the GDP calculation and will be reflected in corporate earnings and profits.
The recent slide, notwithstanding the "reflexive bounce" on Monday, was beginning the process of pricing in negative earnings growth through the end of 2020.
Importantly, earnings estimates have not been ratcheted down yet to account for the impact of the "shutdown" to the global supply chain. Once we adjust (dotted blue line) for the negative earnings environment in 2020, with a recovery in 2021, you can see just how far estimates will slide over the coming months. This will put downward pressure on stocks for the rest of the year.
Given this backdrop of weaker earnings and economic growth in the coming months, this is why we suspect we could well see this year play out much like 2015-2016.
In 2015, the Fed was beginning to discuss tapering their balance sheet, which initially led to a decline. Given there was still plenty of exuberance, the market rallied back before "Brexit" risk entered into the picture. The market plunged on expectations for a negative economic impact but immediately bounced back after Janet Yellen coordinated with the BOE, and ECB, to launch QE in the Eurozone.
Using that model for a reflexive rally, we will likely see a failed rally and a retest of last week's lows, or potentially even set new lows, as economic and earnings risks are factored in.
Rally To Sell
As expected, the market rallied hard on Monday on hopes that the Federal Reserve, and Central Banks globally, will intervene with a "shot of liquidity" to cure the market's "COVID-19" infection.
The good news is the rally yesterday did clear initial resistance at the 200-dma, which keeps that important break of support from being confirmed. That push also cleared the way for the market to rally back into the initial "sell zone" we laid out this past weekend.
Importantly, while the volume of the rally on Monday was not as large as Friday's sell-off, it was a solid day nonetheless and confirmed the conviction of buyers. With the markets clearing the 200-dma, and still oversold on multiple levels, there is a high probability the market will rally into our "sell zone" before failing.
For now, look for rallies to eventually be "sold."
The End Of The Bull
I want to reprint the last part of this weekend's newsletter as any rally that occurs over the next couple of weeks will NOT reverse the current market dynamics.
"The most important WARNING is the negative divergence in relative strength (top panel). This negative divergence was seen at every important market correction event over the last 25-years."
"As shown in the bottom two panels, both of the monthly 'buy' signals are very close to reversing. It will take a breakout to 'all-time highs' at this point to keep those signals from triggering.
For longer-term investors, people close to, or in, retirement, or for individuals who don't pay close attention to the markets or their investments, this is NOT a buying opportunity.
Let me be clear.
There is currently EVERY indication given the speed and magnitude of the decline, that any short-term reflexive bounce will likely fail. Such a failure will lead to a retest of the recent lows, or worse, the beginning of a bear market brought on by a recession.
Please read that last sentence again.
Bulls Still In Charge
The purpose of this analysis is to provide you with information to make educated guesses about the "probabilities" versus the "possibilities" in the markets over the weeks, and months, ahead.
It is absolutely "possible" the markets could find a reason to rally back to all-time highs and continue the bullish trend. (For us, such would be the easiest and best outcome.) Currently, the good news for the bulls, is the bullish trend line from the 2015 lows held. However, weekly "sell signals" are close to triggering, which does increase short-term risks.
With the seasonally strong period of the market coming to its inevitable conclusion, economic and earnings data under pressure, and the virus yet to be contained, it is likely a good idea to use the current rally to rebalance portfolio risk and adjust allocations accordingly.
As I stated in mid-January, and again in early February, we reduced exposure in portfolios by raising cash and rebalancing portfolios back to target weightings. We had also added interest rate sensitive hedges to portfolios, and removed all of our international and emerging market exposures.
We will be using this rally to remove basic materials and industrials, which are susceptible to supply shocks, and financials which will be impacted by an economic slowdown/recession, which will likely trigger rising defaults in the credit market.
Here are the guidelines we recommend for adjusting your portfolio risk:
Step 1) Clean Up Your Portfolio
Tighten up stop-loss levels to current support levels for each position.
Take profits in positions that have been big winners
Sell laggards and losers
Raise cash and rebalance portfolios to target weightings.
Step 2) Compare Your Portfolio Allocation To Your Model Allocation
Determine areas requiring new or increased exposure.
Determine how many shares need to be purchased to fill allocation requirements.
Determine cash requirements to make purchases.
Re-examine portfolio to rebalance and raise sufficient cash for requirements.
Determine entry price levels for each new position.
Determine "stop loss" levels for each position.
Determine "sell/profit taking" levels for each position.
(Note: the primary rule of investing that should NEVER be broken is: "Never invest money without knowing where you are going to sell if you are wrong, and if you are right.")
Step 3) Have Positions Ready To Execute Accordingly, Given The Proper Market Setup.
In this case, we are adjusting exposure to areas we like now, and using the rally to reduce/remove the sectors we do not want exposure too.
Stay alert; things are finally getting interesting.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
This article was written by
After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; I have pretty much "been there and done that" at one point or another. I am currently a partner at RIA Advisors in Houston, Texas.
The majority of my time is spent analyzing, researching and writing commentary about investing, investor psychology and macro-views of the markets and the economy. My thoughts are not generally mainstream and are often contrarian in nature but I try an use a common sense approach, clear explanations and my “real world” experience in the process.
I am a managing partner of RIA Pro, a weekly subscriber based-newsletter that is distributed to individual and professional investors nationwide. The newsletter covers economic, political and market topics as they relate to your money and life.
I also write a daily blog which is read by thousands nationwide from individuals to professionals at www.realinvestmentadvice.com.
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Comments (14)
- because much of the Money is already in.- because there are less Money left;
- because traders/investors become CAUTIOUS.You can chime in 100s of reasons why RSI divergence sell signals (DSS) proved such an 'excellent' choice among uber-bears for shorting the markets.- SnP500 Part I: drive.google.com/...There were also RSI-DSS in mid-1960s that collapsed Dow Jones and SnP500, including a major DSS from 1967 ATH to 1973 ATH that resulted into 1973/74 Severe Recession where SnP500 lost 48% and 45% for Dow Jones. - the Big Picture: drive.google.com/...1965 to 1974 turned out to be the first time only one (1) Lost Decade happened lasting only 9 years top to bottom --- instead of four (4) lost decades in early 1900s that include WWI + Great Depression + WWII; that bottomed out in 1942 when the USA started sending tens of millions of American soldiers to the Death Valleys of Europe in response to 1941 Pearl Harbor Attack (/to end all world wars once and for all).But then: RSI suddenly stopped producing DSS in 1996, worse still SnP500 kept rallying to new ATHs in early to late 1980s producing good! Good! and Great!!! momentum runs that super-squeezed the uber-bears. Worst still, the RSI-DSS of early 1989 to early 1990s resulted in more short-squeezes that finally broke the back of uber-bears resulting into massive FOMO induced Irrational Exuberance of 1996 to 2000 where SnP500 gained additional whopping 156% while Nasdaq went crazy with more than 400% gains in just 4 years.- 1982-1987 DSS: drive.google.com/...
- 1996-2000 DSS: drive.google.com/...- 2002-2007 DSS: drive.google.com/...1982/87 and 1996/2000 were excellent small bear traps learned by expert traders during the massive vertical rallies of the 80s and 90s. But then it was practically a drought during the anemic 107% rally of 2002 to 2007 lasting 5 years, possibly the worst performing bull run in history, that resulted into a small DSS in October 2007 breaking the backbone of SnP500, the so-called last straw.--------------------How about Now?- SnP500 Part II: seekingalpha.com/...RSI reached an All-Time-High in 1996, a massive momentum never seen before, not even during the massive 23 years of secular rally from 1942 to 1965 w/1967 ATH. Which in turn resulted into numerous BTFDs and short-squeezes each time minor divergence sell signal failed.Unfortunately, like 1973, SnP500 produced a big-daddy RSI-DSS in 2007 supported by a baby DSS in October 2007 that resulted into excellent precision short setup for the contrarians. The rest was history very similar to 1973/74 Severe Recession and 1965/74 Lost Decade. Highly reliable history repeating itself almost exactly with 2008/09 Great Recession and 2000-2009 Lost Decade.,But then again, SnP500 again produced another RSI momentum run that short-squeezed the uber-bears multiple times using small divergence sell signals (bear traps) much like in late 1970s to early 1980s DSS'es. Small but painful short-squeezes.- Strategic Plan A: drive.google.com/...Well, we've got a new Good! Goodah! Great!!! pattern very similar to 1982 to 1987 that resulted into 38% collapse in October Black Swan. And also resulted into a collapse of SnP500 toward the monthly 50ma support very similar to October 1997, but with only 20.14% minor bear this time around.- 1982-87 bull run: 251% gains, 26% CAGR, 173% P/Eexp;
- 2009/18 bull run: 330% gains, 17% CAGR, 27% P/Eexp.Obviously, SnP500 was over-speeding in 1982-87 bull run with nosebleed P/E expansion of 173%. What would you expect to happen next?- Fiscal Stimulus Plan B: drive.google.com/...
- the FOMO Runs: drive.google.com/...Plan A became feasible in October 2011 during the EU Debt Crisis that became my primary roadmap that proved to be excellent performer. Plan B probable only in late 2017 was unexpected but then again better to have an alternate plan rather than none. It complicates all my trading/investment strategies to no end, but is still a welcome sight despite all the headaches suffered these past few years.For tutorial purposes only. Cheers and Good Luck.
Therefore, yesterday close or this morning were the moment to take actions if one wants to ride the rebound ..(Edited)
1)Yesterday market quickly sold off at close, technical reason was that the 5 period of DMA was not in place yet .. combined with the Monday huge up, yesterday's move was a process to let 5 period DMA construct a bottom or changing direction. Last night future ES development made this reading even clear .. that 5 period DMA was in its position for a direction change.
If this happens, it at least signifies a local bottom ( tradable bottom) for the current market ...
2) Next story is about 20 DMA, this DMA is pressing down.. market is rebounding and moving to meet this pressing down DMA, fighting will happen over there, 3200~3250 area.
If 20 DMA wins, market will have to construct W shape rebound, if current rebound succeeds , V shape rebound will happen.. Both sides have strong arguments !
