Tag Archives: sell-off

The Ghosts Of 2007 Are Calling

Borrowing from Mark Twain, a headline in the Chicago Tribune in 1941 said: “History May Not Repeat, But It Looks Alike.” Real or imagined that is often the case in financial markets especially when perusing historical price charts of stocks, bonds, commodities or any financial instrument for that matter. Comparing charts of some financial index or security from different time frames in search of resemblance is known as an analogue. Although one may occasionally find an uncanny similarity, it does not usually offer much in the way of influence over decision-making. Then again, there are some circumstances where charts align and we would be well-served to pay attention if not for purposes of immediate action, then as a means of allowing for better preparation.

One famous example involved hedge fund manager Paul Tudor Jones who in 1987 picked up on similarities in the price action and chart pattern of the Dow Jones Industrial Average that year and what transpired in 1929. Watching the progression of the stock market in 1987, he was convinced a market crash was coming. And come it did.

While analogues may seem contrived, the concept makes sense. Technical charts in all their forms are simply a reflection of human beings and their decisions about buying and selling. They are a visual representation of human emotion, and although difficult to predict, there is a pattern to how human beings behave in markets.

2006-2007

With that said, the developing price action of the S&P 500 has held our attention for several weeks. Below is a chart of the S&P 500 from two different time frames. The top frame is a chart from October 2006 to November 2007. The bottom frame is from October 2017 to the current day.

Data Courtesy Bloomberg

In early 2007 when everyone felt invincible due to home price appreciation and stock market gains, the first reports of subprime losses began to roil earnings reports for banks. Although initially disruptive, the market shrugged off those concerns and moved higher throughout spring and summer. The S&P 500 hit all-time highs in October, two months before the beginning of the recession and three months before a speech on January 10, 2008, in which Fed Chairman Bernanke stated: “The Federal Reserve is not currently forecasting a recession.”

The equity market contours have definitively changed in 2018 versus preceding years. An initial surge in equities in the opening weeks of 2018 was followed by a 10% decline and a long-absent spike in volatility. However, after the initial disruption in late January, the bull market managed to find its legs. By summer, the market was steadily rising and established new all-time highs in late September.

While the patterns do not line up perfectly, the symmetry of time, record highs, and the confluence of many potentially unstable events is certainly comparable.

2018

If 2006-2007 represents a proper analogue, the all-time high recently set on September 21st was the end of the great post-crisis, stimulus-fueled bull-run. It is early yet, and many prior calls for market tops lie in a graveyard full of bear bones. However, the analogue, when coupled with valuation analysis, liquidity concerns and economic data suggest that there is a likelihood that what we are observing is a topping process to the ten-year bull market.

Unlike 2007 where early disbelief around housing market excess and subprime lending finally offered easily identifiable culprits, today, like terrorism, the villains are not so easily identified. We live so deeply embedded in a world of debt and spending, a world so far away from fiscal discipline and prudence, that the tactics of ultra-low interest rates and quantitative easing now seem natural and healthy. Simply they have blinded our perspective.

Isaac Newton’s third law of physics states that “for every action, there is an equal and opposite reaction.” Years of monetary excess and the rampant speculation that resulted might be finally reversing. Regardless of whether the market is topping as the analogue warns or avoids significant declines for another year or two, investors would be well-served to be aware. The risk/reward framework is not in our favor.

Dissecting This Selloff

Comparing the 10% market dip that occurred in the first quarter of 2018 to the current decline can provide us clues as to whether 2018 is a period of consolidation or the makings of a bearish topping process. As the charts reflect, there are some similarities and differences between the two periods.

We start with the weekly chart of the S&P 500 shown below.

Candle Structure

The first two weeks of each sell-off were nearly identical when viewed using candles, as highlighted in the graph below.

Note the similarity of the long second candle in each shaded area which occurred during the second week of each sell-off period. In the January-April timeframe, the second candle was the longest candle of the period, and its bottom proved to be the low for the entire time frame. That low was tested in April and it held. In the current period, the market has so far failed to bounce higher following the early October lows. Further, as of writing this, the S&P 500 has broken below that candle’s low point.

Trend Line Support

During the January – April period, all of the weekly closes stayed above the dotted black trend line, which has reliably supported the market since early 2016. In the current period, the second weekly close finished well below the trend line and the market has continued to trade further below it since.

34-Week Moving Average

While not perfect, the 34 -week moving average (orange) has demonstrated reasonable support for the market since 2016. Currently, the S&P 500 is 80 points below that moving average, and it is not, at least yet, proving supportive. Another weekly close below that level will offer more conclusive evidence of a meaningful breach.

The slope of the 34 -week moving average continued upward throughout the January – April period without any degradation in trajectory. Currently, the slope, while still upward, has flattened considerably.

The 20 -week moving average (green) turned lower in the sixth week of the January – April decline. It turned lower in the second week of the current decline.

The 34 -week moving average and the trend line are important markers to follow. When the market bounces, the next test will be to see if it can rise above these lines or if they become resistance.

Volatility

In the first week of February, the S&P 500 Volatility Index (VIX) went from 12.5 to over 50. This was a signal of distress in the market and likely a signal of illiquid conditions driven by impetuous selling. That spike was also fueled by concentrated selling due to the failure of poorly constructed short VIX ETFs. Currently, the VIX has risen from the same 12.5 to 25. Our concern is that this move is not as driven by fear which might lead to a more measured and durable sell-off.

Traditional Safe Havens

On January 26, 2018, when the S&P 500 peaked, gold closed at 1352. Over the next three months, as the S&P fell over 10%, gold was never able to close above that level.

On October 3, 2018, when the current decline started gold closed at 1202. As of October 23, it stands above 1230. This time around, unlike the prior decline, gold is reacting positively as a safe haven.

During the first three weeks of the January – April decline, U.S. Treasury yields rose, and prices fell. Typically during periods of market stress, yields decline as investors seek safety. In the current move, yields have declined since early October. While that decline in yields has been moderate, U.S. Treasuries are acting more like a safe haven than earlier in the year.

Summary

This second decline of the year is showing signs that are a little more concerning than those offered at the beginning of the year. While the moves may appear somewhat similar thus far in regards to points lost, the differences should be watched closely. The question we must consider is, are we simply in a period of consolidation before the bull market resumes or is this a bearish topping process?

One other comparison bears mentioning. In 2007, the market peaked at record highs in February, recovered and set new record highs over the next eight months before setting a final top in October 2007.

In addition to following the signals detailed above, the low set on February 9, 2018, of 2532 is an important line in the sand. As long as the S&P stays above that line, we must assume the bullish trend since 2009 is intact and the ups and downs of 2018 are merely a period of consolidation. A break below that line leads us to believe further that we may be in the midst of a topping process. Given extreme valuations and the poor risk/reward dynamics offered by stocks, we urge caution and responsiveness as the market further presents itself.

For more on our most current technical thoughts, please read our latest Technically Speaking.