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.

 

Bank of Japan Governor Haruhiko KurodaHaruhiko 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:

 

1-DJIA-1961-1962The DJIA from 1961 to 1962. We may be at the beginning of the period equivalent to the one in the green rectangle – click to enlarge.

 

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.

 

2-TNXAssuming 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:

 

3-Initial claimsThe reversal in the short term trend in initial claims lends support to the idea that the stock market is in for a sizable rebound – click to enlarge.

 

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”.

 

4-VIX and CPCEThe VIX and the equities only put-call volume ratio. Traders have shown no signs of grave concern – yet – click to enlarge.

 

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.

 

(emphasis added)

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.

 

5-Nikkei, dailyThe Nikkei jumps by more than 1,000 points, or 7.16% on Monday – click to enlarge.

 

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.

 

6-DJIA 2008Record 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.

 

Conclusion

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

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to ““Stimulus Hopes” – a Dog that Ain’t Hunting no More”

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Perfect-InvestmentInsanity, Oddities and Dark Clouds in Credit-Land
      Insanity Rules Bond markets are certainly displaying a lot of enthusiasm at the moment – and it doesn't matter which bonds one looks at, as the famous “hunt for yield” continues to obliterate interest returns across the board like a steamroller. Corporate and government debt have been soaring for years, but investor appetite for such debt has evidently grown even more.   The perfect investment for modern times: interest-free risk! Illuustration by Howard...
  • Factories, new vs oldUS Economy – Something is not Right
      Another Strong Payrolls Report – is it Meaningful? This morning the punters in the casino were cheered up by yet another strong payrolls report, the second in a row. Leaving aside the fact that it will be revised out of all recognition when all is said and done, does it actually mean the economy is strong?   Quo vadis, economy? Image credit: Paul Raphaelson   As we usually point out at this juncture: apart from the problem that US labor force participation has...
  • TurmoilInvesting in Gold in 2016: Global Paradigm Shifts in Politics and Markets
      Crumbling Stability In the past few months, we have witnessed a series of defining events in modern political history, with Britain’s vote to exit the EU, (several) terror attacks in France and Germany, as well as the recent attempted military coup in Europe’s backyard, Turkey.   Global stability continues to be undermined   Uncertainty over Europe’s political stability and the future of the EU keeps growing. These worries are quite valid, as geopolitical...
  • CorporateMediacontrolTrump's Tax Plan, Clinton Corruption and Mainstream Media Propaganda
      Fake Money, Fake Capital OUZILLY, France – Little change in the markets on Monday. We are in the middle of vacation season. Who wants to think too much about the stock market? Not us! Yesterday, Republican presidential candidate Donald Trump promised to reform the U.S. tax system.   This should actually even appeal to supporters of Bernie Sanders: the lowest income groups will be completely exempt from income and capital gains taxes under Trump's plan. We expect to hear...
  • mania1The Great Stock Market Swindle
      Short Circuited Feedback Loops Finding and filling gaps in the market is one avenue for entrepreneurial success.  Obviously, the first to tap into an unmet consumer demand can unlock massive profits.  But unless there’s some comparative advantage, competition will quickly commoditize the market and profit margins will decline to just above breakeven.   Example of a “commoditized” market – hard-drive storage costs per GB. This is actually the essence of economic...
  • Mark Carney starts work as Bank of England governor in Dave Simonds cartoonBank of England QE and the Imaginary “Brexit Shock”
      Mark Carney, Wrecking Ball For reasons we cannot even begin to fathom, Mark Carney is considered a “superstar” among central bankers. Presumably this was one of the reasons why the British government helped him to execute a well-timed exit from the Bank of Canada by hiring him to head the Bank of England (well-timed because he disappeared from Canada with its bubble economy seemingly still intact, leaving his successor to take the blame).   This is how Mark Carney is seen by...
  • kids-2Why Americans Get Poorer
      Secular Stagnation OUZILLY, France – Both our daughters have now arrived at our place in the French countryside. One brought a grandson, James, now 14 months old. He walks along unsteadily, big blue eyes studying everything around him.   Put to sleep by monetary lullaby! This is what children look like approximately five minutes into a rant on the Fed's policy mistakes. It never fails! Photo credit: Jack Weid   He adjusted quickly to the change in time zones. And...
  • old friendsAn Old Friend Returns
      A Rare Apparition An old friend suddenly showed up out of the blue yesterday and I’m not talking about a contributor who had washed out and, after years of ‘working for the man’, decided to return for another whack at beating the market. Instead I am delighted to report that I am looking at a bona fide confirmed VIX sell signal which we haven’t seen for ages here.   Hello, old friend. Professor X and Magneto staring each other down in the plastic...
  • tortoiseThe Fabian Society and the Gradual Rise of Statist Socialism
      The “Third Way”   “Stealth, intrigue, subversion, and the deception of never calling socialism by its right name” – George Bernard Shaw   An emblem of the Fabian Society: a wolf in sheep's clothing   The Brexit referendum has revealed the existence of a deep polarization in British politics. Apart from the public faces of the opposing campaigns, there were however also undisclosed parties with a vested interest which few people have heard about. And...
  • storming the storeRetail Snails
      Second Half Recovery Dented by “Resurgent Consumer” We normally don't comment in real time on individual economic data releases. Generally we believe it makes more sense to occasionally look at a bigger picture overview, once at least some of the inevitable revisions have been made. The update we posted last week (“US Economy, Something is Not Right”) is an example.   Eager consumers storming a store Photo credit: Daniel Acker / Bloomberg   We'll make an...
  • The CongressThe Fed’s “Waterloo” Moment
      Corrupt and Unsustainable James has been a big help. Trying to get him to sleep at night, we have been telling him fantastic and unbelievable bedtime stories – full of grotesque monsters... evil maniacs... and events that couldn’t possibly be true (catch up here and here).   He turned his head until his gaze came to rest on the barred windows of the main building. Finally, he spoke; as far as I was aware these were the first words he had uttered in more than five years....
  • Zimbabwe_$100_trillion_2009_ObverseGood Money and Bad Money
      Confidence Gets a Boost OUZILLY, France – Last week’s U.S. jobs report came in better than expected. Stocks rose to new records. As we laid out recently, a better jobs picture should lead the Fed to raise rates. This should cause canny investors to dump stocks.   Canny investors at work (an old, but good one...) Cartoon via Pension Pulse   But the stock market paid no attention. It follows logic of its own. Headlines told us that last Friday’s report “boosted...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com