A Rebound in Stocks Begins
Given that a very sharp downturn in so-called “risk assets” is well underway globally, but not yet fully confirmed by US big cap indexes, we are keeping an eye out for confirmation. This is to say, we are looking for events, market moves, positioning data, even newspaper headlines, that will either confirm or refute the notion that a larger scale bear market (as opposed to just a deep correction) has begun.
Haruhiko Kuroda will stimulate us back to Nirvana! Hurrah!
Photo credit: Yuya Shino / Reuters
Readers may recall an article we posted earlier this year, discussing historical examples of the stock market swooning in the seasonally strong month of January (see: “Stock Market Suffers Worst Start to the Year Ever” for details). When the market does something like this, it is more often than not sending a message worth heeding. Chart patterns of course never repeat in precisely the same manner, but such historical patterns are nevertheless often useful as rough guides.
As a reminder, here is a chart of the DJIA from 1961 to 1962. Both the distribution period preceding the sell-off, as well as the timing and pattern of the sell-off itself show many similarities to what has so far occurred in 2015 to 2016:
In keeping with this, we would now normally expect the market to rebound from the initial sell-off and retrace a portion of its losses over a period of several weeks before resuming the decline from a lower high. Last week the bond market delivered a technical signal on the daily chart, which based on well-known inter-market correlations suggests that such a rebound has likely begun.
Assuming that the positive correlation between treasury bond yields and the stock market (resp. the negative correlation between bond and stock prices) persists, the island reversal in bond yields last week is signaling the beginning of a short term relief rally. The bullish consensus in the bond market has recently become extremely stretched, so a rebound in yields would be quite normal – click to enlarge.
A certain degree of support for the idea has also emerged on the US economic data front: for instance, growth in retail sales exceeded expectations. More importantly though, initial unemployment claims, which traditionally are strongly negatively correlated with stock prices, fell sharply last week. In the process they have negated a recent short term uptrend that threatened to lead to a breakout to higher highs:
Crash Risk Still Remains High
There are of course a number of caveats to all of this: Neither the VIX nor put-call volume ratios have so far shown any signs of an emerging panic in the US stock market. If one looks at gold stocks, in spite of the sector being overbought and more than ripe for a pullback, numerous charts of individual gold stocks actually look as though they may have even more short term upside. Since the sector is currently negatively correlated with the broader stock market, this counts as a mildly negative factor for “risk”.
Moreover, as we have pointed out in a recent missive, once a market hovers close to major chart support – as is the case with the S&P 500 index and the DJIA at present – crash risk becomes higher than normal (see: “The Bubble Deflates and Crash Risk Rises” for the details). We would also point readers to John Hussman’s weekly market column, in which he echoes this sentiment:
“Given our focus on historically-informed, value-conscious, full-cycle investing, I generally don’t place much attention on short-term technical factors or specific patterns of price action. However, the current setup is one of the few exceptions. In a market return/risk classification that is already the most negative we identify, where a sustained period of speculation has given way increasing risk-aversion, the position of the market relative to very widely identified “support” (about the 1820 level on the S&P 500) is of particular note.
Often, well-recognized support levels become places where dip-buyers and swing-traders line up on the buy side, on the assumption that they’ll be rewarded if the market bounces from that support, and that they can quickly cut their losses immediately if the support level is broken. The problem here is that when too many speculators set their stop-loss points at the same level, and valuations are still elevated, there may be neither speculators nor value-conscious investors willing to bid for stock anywhere near those support levels once they break. The resulting gap between eager sellers at a high level and willing buyers at a much lower level is the essential element of market crashes, because every seller requires a buyer.
I’ve often observed that market crashes have historically emerged only after a familiar profile of market behavior that features a compressed market retreat of about 14% over 10-12 weeks, a rebound between 1/3 and 2/3 of that decline, a fresh retreat that slightly breaks that initial level of support, a one-day barn-burner advance, and then a collapse as the prior support level is broken. In the 1990’s, I called this pattern the lead-up to “five days of Armageddon” because historically, once rich valuations have been joined with poor market internals (what I used to call “trend uniformity”), the break of a widely-identified support level has often been followed by vertical market losses.
The present widely-followed “support” shelf for the S&P 500 is roughly 14% below the 2015 market peak, but most domestic and international indices have already broken corresponding support levels. Given the obscene valuations at the 2015 peak, my impression is that a run-of-the-mill completion of the current market cycle (neither an unusual nor worst-case scenario from a historical perspective) would comprise an additional market decline of roughly 40-50% from present levels. I certainly don’t expect that kind of market loss in one fell swoop. Rather, my immediate concern is that the first leg of this decline could be quite steep.
In other words, one shouldn’t get carried away by the market’s short term rebound potential. It exists, and it would clearly conform with “standard expectations”. We do assign a large probability to it. But the risk of a sudden and very sharp drop has definitely not gone away just yet.
Bear Market Confirmation from Japan?
Now we come to the what has prompted us to refer to “stimulus hopes” in the title of this post. With US markets closed for President’s Day on Monday, the mice came out to play everywhere else. Gold sold off sharply, and the Nikkei rallied by more than 1,000 points in a single trading day.
Normally people will be inclined to think that such a powerful reversal is a bullish sign. Unfortunately this isn’t the case – the opposite is true. Such rip-roaring one-day rallies are typically a hallmark of bear markets. Readers may recall that there have been a number of huge rallies in the DJIA a few years ago that broke records in terms of points recovered in the space of one to two trading days.
These notable moves occurred in September of 2008. After the SEC banned short selling of a large list of financial stocks in mid September, the DJIA rallied by more than 1,000 points in just two days. On the penultimate trading day of September it again rallied very strongly, recovering nearly 600 points in just one day. Then it crashed.
Record short term rallies in the DJIA before the October 2008 crash. Record one day rallies could incidentally also be observed in the three weeks preceding the 1987 crash and in April of 2000 – click to enlarge.
Note, we are not saying that a big one day rally means a crash is imminent. What we are saying is merely this: when such large short term rallies occur in the course of an initial wave of selling from a multi-year peak, they should be regarded as a bearish sign. This does not mean that a larger rebound cannot take shape over coming weeks. However, it does represent yet another warning.
This is especially so if one considers the headlines and circumstances accompanying the Nikkei’s surge on Monday. The Japanese government published yet another batch of terrible economic statistics. Specifically, the economy once again contracted in Q4 of 2015, for the fourth time in the past seven quarters. Here is how the rally in the Nikkei that started right after the release was explained in the mainstream press:
“Nikkei surges on stimulus hopes” wrote the Business Standard. Reuters reported: “Nikkei posts biggest daily gain in more than 4 months on oil bounce, stimulus hopes”. The Guardian noted along similar lines “Asian and European stock markets rally on stimulus hopes”. Countless similar headlines appeared all over the world.
Stimulus hopes? Seriously? Only a little while ago the press finally got around to noticing that the imposition of negative interest rates in Europe and Japan had backfired badly and was seemingly about to annihilate blind faith in central planners. We believe that absolutely nothing has changed on this front. The “stimulus” dog ain’t hunting anymore, even though we still come across declarations of faith such as this recent one by Deutsche Bank equity strategists, who asserted that “Only the Fed can Save Stocks Now”.
Well, no. It actually cannot – and neither can the BoJ or the ECB. It is a serious misconception to believe that central banks have “control” over what the stock market does next. There is a big difference between the ability to exert influence on the extent and duration of bubbles while they are underway and stopping a bear market from playing out.
People often end up losing a lot of money in bear markets because they believe that these things actually matter. Hopes are kept alive and as a result many people stay fully invested in the market at the worst possible time. Of course, in the aggregate these losses cannot be avoided anyway – after all, someone will always end up holding stocks. For every investor who manages to avoid further losses by selling, another investor steps up to the plate to take them instead.
We would assign a very high probability to a market rebound lasting several weeks, which would allow for oversold conditions to be relieved and recent positioning extremes in stock index futures to be mitigated. One must keep in mind though that nearby support levels will have to hold – if they are violated in the near term, the extant crash risk would likely materialize.
Regardless of the market’s near term gyrations though, the manner in which overseas markets have turned around on Monday should be seen as another medium term warning sign – not only on technical grounds, but also based on the faulty reasoning forwarded by market observers.
As we always stress, central banks definitely can goose stock prices even under the worst economic conditions, if they proceed to utterly destroy the currency they issue. This has e.g. most recently happened in Venezuela. However, our working assumption at this juncture remains that developed market central banks are highly unlikely to pursue such a course. After all, they all have “inflation targets” – and while they have obviously no control over price inflation either, we assume they will tighten policy should these targets be materially exceeded.
Pinning one’s hopes on “more stimulus” definitely strikes us as a mug’s game at the current juncture though.
Charts by: StockCharts, Acting Man
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to ““Stimulus Hopes” – a Dog that Ain’t Hunting no More”
Most read in the last 20 days:
- Gold Sector Update – What Stance is Appropriate?
The Technical Picture - a Comparison of Antecedents We wanted to post an update to our late December post on the gold sector for some time now (see “Gold – Ready to Spring Another Surprise?” for the details). Perhaps it was a good thing that some time has passed, as the current juncture seems particularly interesting. We received quite a few mails from friends and readers recently, expressing concern about the inability of gold stocks to lead, or even confirm strength in gold of...
- Don’t Blame Trump When the World Ends
Alien Economics There was, indeed, a time when clear thinking and lucid communication via the written word were held in high regard. As far as we can tell, this wonderful epoch concluded in 1936. Everything since has been tortured with varying degrees of gobbledygook. One should probably not be overly surprised that the abominable statist rag Time Magazine is fulsomely praising Keynes' nigh unreadable tome. We too suspect that this book has actually lowered the planet-wide IQ –...
- Incrementum Advisory Board Meeting, Q1 2017 and Some Additional Reflections
Looming Currency and Liquidity Problems The quarterly meeting of the Incrementum Advisory Board was held on January 11, approximately one month ago. A download link to a PDF document containing the full transcript including charts an be found at the end of this post. As always, a broad range of topics was discussed; although some time has passed since the meeting, all these issues remain relevant. Our comments below are taking developments that have taken place since then into...
- What is the Best Time to Buy Stocks?
Chasing Entry Points Something similar to the following has probably happened to you at some point: you want to buy a stock on a certain day and in order to time your entry, you start watching how it trades. Alas, the price rises and rises, and your patience begins to wear thin. Shouldn't a correction set in soon and provide you with a more favorable buying opportunity? Apple-Spotting – a five minute intraday chart showing the action in AAPL on February 1, 2017 - an...
- Trump and the Draining of the Swamp
Swamp Critters BALTIMORE – The Dow is back above the 20,000-point mark. Federal debt, as officially tallied, is up to nearly $20 trillion. The two go together, egging each other on. The Dow is up 20 times since 1980. So is the U.S. national debt. Debt feeds the stock market and the swamp. What’s not up so much is real output, as measured by GDP. It’s up only 6.4 times over the same period. Debt and asset prices have been rising three times as fast as GDP for 36 years! Best...
- Gold and Silver Divergence – Precious Metals Supply and Demand
Gold and Silver Divergence – Precious Metals Supply and Demand Last week, the prices of the metals went up, with the gold price rising every day and the silver price stalling out after rising 42 cents on Tuesday. The gold-silver ratio went up a bit this week, an unusual occurrence when prices are rising. Everyone knows that the price of silver is supposed to outperform — the way Pavlov’s Dogs know that food comes after the bell. Speculators usually make it...
- When Trumponomics Meets Abenomics
Thirty Year Retread What will President Trump and Japanese Prime Minister Shinzo Abe talk about when they meet later today? Will they gab about what fishing holes the big belly bass are biting at? Will they share insider secrets on what watering holes are serving up the stiffest drinks? [ed. note: when we edited this article for Acting Man, the meeting was already underway] Japan's prime minister Shinzo Abe, a dyed-in-the-wool Keynesian and militarist, meets America's...
- The Great Wailing
Regret and Suffering BALTIMORE – Victoribus spolia... So far, the most satisfying thing about the Trump win has been the howls and whines coming from the establishment. Each appointment – some good, some bad from our perspective – has brought forth such heavy lamentations. Oh no! Alaric the Visigoth is here! Hide the women and children! And don't forget the vestal virgins, if you can find any... You’d think Washington had been invaded by Goths, now...
- Receive a One Percent Gift When Buying or Selling a Home
How to Save Money When Buying or Make More When Selling a Home In your professional capacity and perhaps also in your private life, you may be closely involved with financial and commodity markets. Trading in stocks, bonds or futures is part of your daily routine. Occasionally you probably have to deal with real estate as well though – if you e.g. want to purchase an apartment or a house, or if own a home you wish to sell. The people who took this photograph probably want to...
- Silver Futures Market Assistance – Precious Metals Supply and Demand
Silver Is Pushed Up Again This week, the prices of the metals moved up on Monday. Then the gold price went sideways for the rest of the week, but the silver price jumped on Friday. Taking off for real or not? Photo credit: NASA Is this the rocket ship to $50? Will Trump’s stimulus plan push up the price of silver? Or just push silver speculators to push up the price, at their own expense, again? This will again be a brief Report this week, as we are busy...
- Unleashing Wall Street
To Unleash or Not to Unleash, That is the Question... LOVINGSTON, VIRGINIA – Corporate earnings have been going down for nearly three years. They are now about 10% below the level set in the late summer of 2014. Why should stocks be so expensive? Example of something that one should better not unleash. The probability that a win-lose proposition will develop upon meeting it seems high. It wins, because it gets to eat... Image credit: Urs Hagen Oh,...
- Boondoggles for the Swamp Critters
Monster or Mozart? BALTIMORE – Investors seem to be holding their breath, like a man hiding a cigarette from his wife. It’s just a feeling, and it’s not the first time we’ve had it... but it feels as though it wouldn’t take much to send them all running. Actually, they're not going anywhere yet... but there is a lot of overconfidence by those who were very worried when prices were a lot better - click to enlarge. Meanwhile... we’re coming to a deep...