11.22.2011
As expected in our October 28th outlook, the US equity market has continued its long term downtrend and confirmed a new intermediate term downtrend as well. After its exhaustive buyers’ capitulation on October 27th, the market traded sideways in volatile fashion into mid-November. The major indices then broke decisively below multi-week ranges and key moving averages, confirming the continuation of the long term downtrend that began in early May, as well as a new intermediate term downtrend that began on October 27th.
As the rate of advance from the October low to October high was unsustainable (see prior post), the necessary outcome was a consolidation of some sort thereafter. The consolidation in the first half of November, followed by the subsequent move lower the past two days was the most likely and most bearish outcome. There is now a high probability of downtrends continuing in the weeks ahead. Developed European as well as global emerging market equity indices have all fallen into intermediate downtrends and remain in long term downtrends as well, thus increasing confidence in lower prices to come.
However, neither implied nor realized volatility has confirmed the new intermediate term downtrend in equities. While the overall level of volatility remains quite high, it remains significantly below highs seen in August, September and early October. In addition, volatility has failed to breach highs seen as recently as mid- and early-November, despite the major equity indices slicing below their respective multi-week lows. Taken alone, this is a bullish development, as it indicates that the recent declines in equities have occurred in a more orderly manner than in August-October. All the same, implied volatility has climbed significantly as the market has declined since October 27th, so the likelihood is that volatility will increase as the market continues to move lower.
In summary, equity markets are poised to go lower in the weeks ahead. Here are several scenarios:
1. Multi-day bounce, then test of August-October lows within weeks
2. False break above this week’s high, then test of August-October lows within weeks
3. No consolidation or bounce – vertical drop to August-October lows
4. Multi-week consolidation, then test of August-October lows a few weeks thereafter
Large US financial stocks have already started nearing their October and multi-year lows. The major equity indices are likely to follow before long.
Tuesday, November 22, 2011
Friday, October 28, 2011
The Test
10.28.2011
Our call for a likely multi-week rally three weeks ago has turned out to be accurate. Equity markets worldwide have experienced anomalously large gains since the October 4th lows, with many indices up more than 15%. As strong as this intermediate term rally has been, long-term downtrends in the major US equity indices have not been broken. The NASDAQ and S&P500 both tested long-term downtrends this week – sustained moves higher in the weeks ahead are necessary to confirm new long-term uptrends.
If the market does not revert back below the lows of October 27th in the next week or so, then the probability is high that a new long-term uptrend has emerged. However, signs have appeared that indicate the uptrend off the October lows is aging – former leaders have fallen hard, former lagging stocks and sectors are attracting money at the expense of former leading sectors, and aggressive sellers have made their presence known.
The rate of advance since the October lows is unsustainable and has characteristics of a bear market rally. Structural shorts, or, those who believe the market has entered into a long-term downtrend, have likely begun to reinitiate positions this week, as rallies have been spiky and have drawn in aggressive sellers at levels of resistance. This group of sellers will remain active henceforth. The deciding factor in the long term trend of the market will be the aggressiveness of the buyers: will they continue to overpower the sellers as they have since the October lows? Or have they put all the money they wish back into the market already?
We see the following scenarios as most likely in the weeks ahead:
1. Continued consolidation around current levels with false upside breakouts, then resumption of the long term downtrend; possible test and breach of October lows several weeks thereafter
2. Consolidation then breakout above this week’s highs to confirm new long term uptrend; possible new highs for the year within weeks to a month or two thereafter
While these two scenarios are polar opposites, it is clear that price stability has not yet been established, which lends a greater weighting to Scenario 1. Additionally, the long-term downtrends of the major European equity indices, the Dow Jones World Stock Index and the Emerging Markets Index have not even been tested. While the gains in the month of October have been impressive, the long-term downtrends set in motion in early May of this year have yet to be fully extinguished. There will be a battle in the weeks ahead between buyers and sellers, and plenty of articulate arguments for both the bearish and bullish side. What is important is whether the markets are able to sustain around the highs of this week. This is a binary outcome situation, which is why the moves of the past few days have been emotionally driven and quite large. If the VIX volatility index, which has come off significantly in recent weeks, continues to decline and realized volatility does the same, then the market will likely continue to rally for months. Otherwise, a resumption of long-term downtrends has a high probability of coming soon.
Our call for a likely multi-week rally three weeks ago has turned out to be accurate. Equity markets worldwide have experienced anomalously large gains since the October 4th lows, with many indices up more than 15%. As strong as this intermediate term rally has been, long-term downtrends in the major US equity indices have not been broken. The NASDAQ and S&P500 both tested long-term downtrends this week – sustained moves higher in the weeks ahead are necessary to confirm new long-term uptrends.
If the market does not revert back below the lows of October 27th in the next week or so, then the probability is high that a new long-term uptrend has emerged. However, signs have appeared that indicate the uptrend off the October lows is aging – former leaders have fallen hard, former lagging stocks and sectors are attracting money at the expense of former leading sectors, and aggressive sellers have made their presence known.
The rate of advance since the October lows is unsustainable and has characteristics of a bear market rally. Structural shorts, or, those who believe the market has entered into a long-term downtrend, have likely begun to reinitiate positions this week, as rallies have been spiky and have drawn in aggressive sellers at levels of resistance. This group of sellers will remain active henceforth. The deciding factor in the long term trend of the market will be the aggressiveness of the buyers: will they continue to overpower the sellers as they have since the October lows? Or have they put all the money they wish back into the market already?
We see the following scenarios as most likely in the weeks ahead:
1. Continued consolidation around current levels with false upside breakouts, then resumption of the long term downtrend; possible test and breach of October lows several weeks thereafter
2. Consolidation then breakout above this week’s highs to confirm new long term uptrend; possible new highs for the year within weeks to a month or two thereafter
While these two scenarios are polar opposites, it is clear that price stability has not yet been established, which lends a greater weighting to Scenario 1. Additionally, the long-term downtrends of the major European equity indices, the Dow Jones World Stock Index and the Emerging Markets Index have not even been tested. While the gains in the month of October have been impressive, the long-term downtrends set in motion in early May of this year have yet to be fully extinguished. There will be a battle in the weeks ahead between buyers and sellers, and plenty of articulate arguments for both the bearish and bullish side. What is important is whether the markets are able to sustain around the highs of this week. This is a binary outcome situation, which is why the moves of the past few days have been emotionally driven and quite large. If the VIX volatility index, which has come off significantly in recent weeks, continues to decline and realized volatility does the same, then the market will likely continue to rally for months. Otherwise, a resumption of long-term downtrends has a high probability of coming soon.
Wednesday, October 5, 2011
Resolution
10.5.2011
The eight-week trading range from early-August to late-September was finally breached the first two days of October. The move came to the downside, which was the most likely scenario. Our call for a very brief dip below the August 9th lows turned out to be correct. Last week we outlined a likely breach lasting several hours to no more than a few days – as it happened, the S&P500 remained below the August 9th low for a total of seven trading hours before a tremendous late-day rally on October 4th brought the index back above the August 9th low.
As the market has behaved just as expected, given the influences of current long-term and intermediate-term downtrends, clarity on the likely path of the market for the coming weeks and months has increased. There are four likely scenarios from here:
1. Market reverses down immediately, breaches the October 4th low, continues lower for a couple of days more, then rallies for several weeks to a month or two
2. Market rallies for several more days, perhaps a week or so, then retests the October 4th low
3. Market consolidates sideways for a few days, nears or retests the October 4th low, then rallies for several weeks to a month or two
4. Market continues to rally strongly off the October 4th low for several weeks to a month or two
We see Scenario 2 or 4 as most likely, Scenario 3 slightly less likely, and Scenario 1 as the outlier.
As the long-term downtrend that began on May 2nd remains intact, all rallies are likely to fail at some point. The key will be to determine when and where the failures are likely to occur. As the market continues to digest ongoing news flow regarding the economy, corporate earnings, and sovereign debt in the months ahead, the likelihood of a ‘surprising’ rally lasting several weeks to a month or two is now high. However, the rally is unlikely to breach the 2011 highs before failing and perhaps testing the October 4th low.
Markets tend to move relatively smoothly in long-term uptrends and choppily in long-term downtrends. This is due to the fact that downtrends trigger heightened emotional responses, which lead to markets overreacting to the downside, which leads to violent swings back upward. The very long-term tendency for money to generally flow into the equity market is another factor that creates choppiness during downtrends, as underlying long-term buyers do battle with cyclical sellers. We have seen this battle play out the past two months, and it will be ongoing for the foreseeable future.
In summary, there is a high likelihood that a multi-week rally has begun or will begin sometime in October. If the advance continues in a vertical fashion the next few days, there is a greater likelihood that the market will retest the October 4th low before any multi-week rally can occur. However, once the market does pivot into an intermediate-term uptrend, the rally may extend for a month or more thereafter.
The eight-week trading range from early-August to late-September was finally breached the first two days of October. The move came to the downside, which was the most likely scenario. Our call for a very brief dip below the August 9th lows turned out to be correct. Last week we outlined a likely breach lasting several hours to no more than a few days – as it happened, the S&P500 remained below the August 9th low for a total of seven trading hours before a tremendous late-day rally on October 4th brought the index back above the August 9th low.
As the market has behaved just as expected, given the influences of current long-term and intermediate-term downtrends, clarity on the likely path of the market for the coming weeks and months has increased. There are four likely scenarios from here:
1. Market reverses down immediately, breaches the October 4th low, continues lower for a couple of days more, then rallies for several weeks to a month or two
2. Market rallies for several more days, perhaps a week or so, then retests the October 4th low
3. Market consolidates sideways for a few days, nears or retests the October 4th low, then rallies for several weeks to a month or two
4. Market continues to rally strongly off the October 4th low for several weeks to a month or two
We see Scenario 2 or 4 as most likely, Scenario 3 slightly less likely, and Scenario 1 as the outlier.
As the long-term downtrend that began on May 2nd remains intact, all rallies are likely to fail at some point. The key will be to determine when and where the failures are likely to occur. As the market continues to digest ongoing news flow regarding the economy, corporate earnings, and sovereign debt in the months ahead, the likelihood of a ‘surprising’ rally lasting several weeks to a month or two is now high. However, the rally is unlikely to breach the 2011 highs before failing and perhaps testing the October 4th low.
Markets tend to move relatively smoothly in long-term uptrends and choppily in long-term downtrends. This is due to the fact that downtrends trigger heightened emotional responses, which lead to markets overreacting to the downside, which leads to violent swings back upward. The very long-term tendency for money to generally flow into the equity market is another factor that creates choppiness during downtrends, as underlying long-term buyers do battle with cyclical sellers. We have seen this battle play out the past two months, and it will be ongoing for the foreseeable future.
In summary, there is a high likelihood that a multi-week rally has begun or will begin sometime in October. If the advance continues in a vertical fashion the next few days, there is a greater likelihood that the market will retest the October 4th low before any multi-week rally can occur. However, once the market does pivot into an intermediate-term uptrend, the rally may extend for a month or more thereafter.
Tuesday, September 27, 2011
The Fight Continues
9.27.2011
Since our last post here two weeks ago, the S&P500 has had a large trading range of 9.5% top to bottom, yet has moved a net sum of .3% higher in that time. The market remains in the same ‘fight zone’ referenced two weeks ago. However, we now have more information on which to base our outlook.
Two key events have occurred just in the past week in the US equities market: a significant lower high and a significant test of the August low. The lower high made on September 20th was significant because it did what was expected of an intermediate-term downtrend within a long-term downtrend: buyers stalled, then aggressive sellers returned before the market could pivot above its prior swing high which was made on August 31st.
The second event, the test of the August low, was significant for several reasons. The first is the fact that the test occurred so rapidly after the swing high – there was true seller aggression all the way down to the closing low of August 8th, and it got to the low in only two days. The second important aspect of this test of support was the fact that the selling dried up very quickly – within one day – upon testing the low. Clearly there is some level of value there, as buyers are able to gain control from the sellers when the market is at the level of the August low. The third important point is the fact that the market rallied vertically the next two and a half days with very little in the way of selling. This presence of buyers remaining in the market at the low end of the now eight-week trading range means that the trading range will remain intact indefinitely.
However, as last week’s test of the August low was the third such test, any subsequent arrival there in the short term is likely to frustrate the buyers, who will likely dump stocks in an emotional, capitulative move below the August low. The likelihood of the market remaining below the August low for more than a few days remains quite low, as bullish divergences continue to proliferate. Therefore, a significant intermediate-term, and possibly long-term, bottom would be likely after any multi-day cascade down below the August low.
The action in the VIX has provided little useful information the past few weeks, as it has simply traded inversely to the equities market. However, the VIX remains anomalously high, currently in the mid-upper 30s, and has not confirmed a new intermediate-term downtrend. One bullish element of the VIX is the decline in the average movement of the measure itself since late-August – this indicates relative comfort with the current level of volatility.
In summary, the market continues to coil sideways, likely in advance of a large move out of its eight-week trading range. With such elevated volatility and emotion continuing to build, a decisive directional move becomes more likely with each passing day. Though the intermediate- and long-term trends favor the downside, signs of underlying strength are increasing. The short-term lines in the sand are now drawn at 1120 on the downside and 1220 on the upside. A breach of this range will likely lead to a significant move in price in whichever direction it should break.
Since our last post here two weeks ago, the S&P500 has had a large trading range of 9.5% top to bottom, yet has moved a net sum of .3% higher in that time. The market remains in the same ‘fight zone’ referenced two weeks ago. However, we now have more information on which to base our outlook.
Two key events have occurred just in the past week in the US equities market: a significant lower high and a significant test of the August low. The lower high made on September 20th was significant because it did what was expected of an intermediate-term downtrend within a long-term downtrend: buyers stalled, then aggressive sellers returned before the market could pivot above its prior swing high which was made on August 31st.
The second event, the test of the August low, was significant for several reasons. The first is the fact that the test occurred so rapidly after the swing high – there was true seller aggression all the way down to the closing low of August 8th, and it got to the low in only two days. The second important aspect of this test of support was the fact that the selling dried up very quickly – within one day – upon testing the low. Clearly there is some level of value there, as buyers are able to gain control from the sellers when the market is at the level of the August low. The third important point is the fact that the market rallied vertically the next two and a half days with very little in the way of selling. This presence of buyers remaining in the market at the low end of the now eight-week trading range means that the trading range will remain intact indefinitely.
However, as last week’s test of the August low was the third such test, any subsequent arrival there in the short term is likely to frustrate the buyers, who will likely dump stocks in an emotional, capitulative move below the August low. The likelihood of the market remaining below the August low for more than a few days remains quite low, as bullish divergences continue to proliferate. Therefore, a significant intermediate-term, and possibly long-term, bottom would be likely after any multi-day cascade down below the August low.
The action in the VIX has provided little useful information the past few weeks, as it has simply traded inversely to the equities market. However, the VIX remains anomalously high, currently in the mid-upper 30s, and has not confirmed a new intermediate-term downtrend. One bullish element of the VIX is the decline in the average movement of the measure itself since late-August – this indicates relative comfort with the current level of volatility.
In summary, the market continues to coil sideways, likely in advance of a large move out of its eight-week trading range. With such elevated volatility and emotion continuing to build, a decisive directional move becomes more likely with each passing day. Though the intermediate- and long-term trends favor the downside, signs of underlying strength are increasing. The short-term lines in the sand are now drawn at 1120 on the downside and 1220 on the upside. A breach of this range will likely lead to a significant move in price in whichever direction it should break.
Tuesday, September 13, 2011
Hurry Up and Wait
The US equities market has continued to experience elevated volatility the past few weeks. It is quite rare for volatility to remain as high as it has since early-August for as long as it has. Other similar periods occurred in late-2008 and early-2009, as well as in 1998 during the Russian debt default /Long Term Capital Management debacle. We are therefore not anywhere close to uncharted territory in terms of volatility, though, certainly, such periods are uncommon and therefore poorly understood.
The VIX volatility index topped out this year at 48 on August 8th, a day before the S&P500 made its intraday low of the year. Since then, the VIX has seen successively lower highs, yet remains above its 30-day simple moving average. During the same time, the S&P500 has seen successively higher lows (with the exception of 9.12’s slight breach below 9.6’s low), and remains below its 30-day simple moving average.
The analysis of such moves in the broad equity market and the VIX shows that the market has been coiling for the past few weeks with roller-coaster moves that have left prices net flat since mid-August. Such indecision on the part of the markets often precedes a large directional move one way or the other. Since the long-term and intermediate-term trends are down, according to our work, the likelihood of lower prices must be weighted as the higher probability.
However, as bullish divergences have already occurred in many stocks and foreign stock indices, the likelihood that US equity indices will breach their August 9 lows for any great duration is quite small at this point in time. Should such a breach occur, it may last only minutes or perhaps as long as a few days. On the other hand, should the market close above its August 31 highs in the next few days or weeks, there is a high likelihood of higher prices thereafter.
As for now, the market remains in the thick of a ‘fight zone’, where buyers and sellers duke it out, and nobody wins for more than a few days. Time to hurry up and wait.
The VIX volatility index topped out this year at 48 on August 8th, a day before the S&P500 made its intraday low of the year. Since then, the VIX has seen successively lower highs, yet remains above its 30-day simple moving average. During the same time, the S&P500 has seen successively higher lows (with the exception of 9.12’s slight breach below 9.6’s low), and remains below its 30-day simple moving average.
The analysis of such moves in the broad equity market and the VIX shows that the market has been coiling for the past few weeks with roller-coaster moves that have left prices net flat since mid-August. Such indecision on the part of the markets often precedes a large directional move one way or the other. Since the long-term and intermediate-term trends are down, according to our work, the likelihood of lower prices must be weighted as the higher probability.
However, as bullish divergences have already occurred in many stocks and foreign stock indices, the likelihood that US equity indices will breach their August 9 lows for any great duration is quite small at this point in time. Should such a breach occur, it may last only minutes or perhaps as long as a few days. On the other hand, should the market close above its August 31 highs in the next few days or weeks, there is a high likelihood of higher prices thereafter.
As for now, the market remains in the thick of a ‘fight zone’, where buyers and sellers duke it out, and nobody wins for more than a few days. Time to hurry up and wait.
Monday, August 29, 2011
Late-Summer Reassessment
As it has now been several weeks since the August 9th low in the US equity markets, it is appropriate to take stock and reassess. Our determination that the market would rally for days or weeks off of the August 9th low turned out to be a good one, as the market remains over 8% higher. The NASDAQ100 did test its August 9th low on August 19th, but it never went below and has rallied quite strongly five of the past six days since then. So the crash is over and the market has spent the past few weeks chopping up and down in very high volatility, trying to find a level of value.
While it is heartening that buyers have returned and halted the early-August cascade down, the major indices have, nonetheless, entered into a long-term downtrend. While this new long-term downtrend can only be ‘confirmed’ upon the market breaching the August 9th lows, the general mode hereafter will likely be rallies that fail after a few weeks to a month or two, then lower lows. Strong rallies like the one(s) we have seen since the August 9th lows are typical of bear markets, as they indicate instability. Sustainable rallies are associated with declining volatility as well as intermediate-term moving averages pointing up, neither of which has occurred the past few weeks.
So far, the two scenarios we believed were most likely in our last post are both still in play, while the two outliers have, indeed, failed to materialize. From this point in time and price, the market may or may not continue going higher before testing the August 9th lows. The choppy rally higher is perhaps the more likely continuation for the short term. Regardless, the further in time we progress without a test of the August 9th lows, the greater the likelihood that, when tested, it will fail.
While it is heartening that buyers have returned and halted the early-August cascade down, the major indices have, nonetheless, entered into a long-term downtrend. While this new long-term downtrend can only be ‘confirmed’ upon the market breaching the August 9th lows, the general mode hereafter will likely be rallies that fail after a few weeks to a month or two, then lower lows. Strong rallies like the one(s) we have seen since the August 9th lows are typical of bear markets, as they indicate instability. Sustainable rallies are associated with declining volatility as well as intermediate-term moving averages pointing up, neither of which has occurred the past few weeks.
So far, the two scenarios we believed were most likely in our last post are both still in play, while the two outliers have, indeed, failed to materialize. From this point in time and price, the market may or may not continue going higher before testing the August 9th lows. The choppy rally higher is perhaps the more likely continuation for the short term. Regardless, the further in time we progress without a test of the August 9th lows, the greater the likelihood that, when tested, it will fail.
Wednesday, August 10, 2011
A Clear Vision of the Markets
The price action in US equities on August 9th strongly suggests that a short-term bottom is in place. After buyers appeared at the open, the market drifted around into the FOMC announcement at 2:15pm. Then sellers tore the market down to a new 11-month low in the S&P. From 2:45pm-4pm, the market then rallied over 6% (!!), finishing the day up 4.7%. While there is no magical formula that reliably catches market bottoms 100% of the time, the most important factor is the activity of buyers. In the downtrend that began in late July, there have been buyers, sometimes very aggressive buyers, at several levels. They appeared for several hours on August 3rd, 5th, and yesterday, August 9th.
The reason that the August 9th buying was significant was due to the aggressiveness, the fierceness of the buyers. There was an all-out rush back into equities for the final 75 minutes of the day, immediately on the heels of a new low for 2011. The market closed at the exact high of the day and had managed to close above the August 8th low as well. This buyers’ rush put an end to the cascading move down in the market. While it is possible that an even larger, scarier move lower is near, the more likely scenario is a continuation to the upside for days, possibly weeks.
Pick your asset class of choice and you can probably make the argument that its price movement in 2011 indicates that the world is imploding. While the markets are trying to keep up with major rapid-fire news (US debt downgrade; FOMC declaration of easy money through mid-2013; Europe backstopping Italian and Spanish debt; etc.), markets tend to overshoot both to the upside and the downside. Since there is an anomalously high level of uncertainty right now across many different strata of market influences (politics, economy, sovereign debt loads, banking system), deleveraging of risk has been the primary reaction by market participants. Because of the existential nature of the problems at hand, the move away from perceived risk and towards perceived security has been extreme. There are now two likely scenarios for equity markets in the upcoming months:
1. Market trades in choppy fashion generally higher, fails to breach the 2011 highs, then heads back down for a test of the August 9th low
2. Market trades in choppy fashion higher for a few days to weeks, then heads back down for a test of the August 9th low
Two outlier scenarios must also be considered.
1. Market rallies in ‘V’ formation back up near the 2011 highs and then goes higher with no test of August 9th low
2. Market continues to drop vertically below the August 9th low
In summary, the short-term looks bullish for equities, the intermediate-term looks bearish, and the long-term is murky but increasingly bearish. One caveat: if the market closes below the August 9th lows, all bets are off and a reassessment is necessary.
The reason that the August 9th buying was significant was due to the aggressiveness, the fierceness of the buyers. There was an all-out rush back into equities for the final 75 minutes of the day, immediately on the heels of a new low for 2011. The market closed at the exact high of the day and had managed to close above the August 8th low as well. This buyers’ rush put an end to the cascading move down in the market. While it is possible that an even larger, scarier move lower is near, the more likely scenario is a continuation to the upside for days, possibly weeks.
Pick your asset class of choice and you can probably make the argument that its price movement in 2011 indicates that the world is imploding. While the markets are trying to keep up with major rapid-fire news (US debt downgrade; FOMC declaration of easy money through mid-2013; Europe backstopping Italian and Spanish debt; etc.), markets tend to overshoot both to the upside and the downside. Since there is an anomalously high level of uncertainty right now across many different strata of market influences (politics, economy, sovereign debt loads, banking system), deleveraging of risk has been the primary reaction by market participants. Because of the existential nature of the problems at hand, the move away from perceived risk and towards perceived security has been extreme. There are now two likely scenarios for equity markets in the upcoming months:
1. Market trades in choppy fashion generally higher, fails to breach the 2011 highs, then heads back down for a test of the August 9th low
2. Market trades in choppy fashion higher for a few days to weeks, then heads back down for a test of the August 9th low
Two outlier scenarios must also be considered.
1. Market rallies in ‘V’ formation back up near the 2011 highs and then goes higher with no test of August 9th low
2. Market continues to drop vertically below the August 9th low
In summary, the short-term looks bullish for equities, the intermediate-term looks bearish, and the long-term is murky but increasingly bearish. One caveat: if the market closes below the August 9th lows, all bets are off and a reassessment is necessary.
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