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By Jani Ziedins | End of Day Analysis
Free After-Hours Analysis:
There is a good chance that weeks from now we will look back at this Tuesday as a key turning point in S&P 500. It was only the second time the index finished in the green in the last ten sessions, but that’s not the only thing that made it feel different. Volume has been ramping up over the previous six sessions and Tuesday’s rebound was the highest of them all. Clearly, something big is happening, the only question is what.
If there is one thing both bulls and bears can agree on, it is that markets don’t move in straight lines. It has been a brutal October for stocks. At the very least, a near-term bounce is overdue. After definitively undercutting the early October lows and setting off a tidal wave of panicked defensive selling, this is about as good of a double-bottom setup as we will ever see.
While nothing in the market is ever certain, double bottoms are some of the most resilient bottoming signals the market gives us. Prices undercut the prior lows, triggering an avalanche of reactionary selling. But rather than trigger the next leg lower, that dip is the last gasp of defensive selling. Once we run out of emotional sellers, supply dries up and prices rebound.
Monday’s frighteningly horrific collapse was as bad as it gets. We opened green, but it was downhill from there and by early afternoon, the index shed more than 100-points. But what if that really was “as bad as it gets”? Maybe, just maybe, that was the worst and everything will get better from here. As the saying goes, it is darkest just before the dawn.
As I already stated, both bulls and bears can agree a bounce is coming. And most bears will even concede that the biggest bounces come in bear markets. This means that no matter which side of the bear/bull debate you stand on, there is an excellent chance this market is ripe for a sharp move higher.
2,700 is the next most obvious price target. But the market likes symmetry and a rebound to 2,700 doesn’t even come close to matching the intensity of October’s selloff. While we could pause and even retrench a little at 2,700 over the next few days, the most likely target for this rebound is the 200dma/2,800/2,820 region the previous bounce stalled at in mid-October. Even rising up to and above the 50dma and the start of this selloff near 2,870 is on the table.
But just like how selloffs don’t go in straights lines, neither do recoveries. After recovering 200-points from the selloff’s lows, it will be time for another dip. How big of a dip depends on which side of the bear/bull debate you fall on, but at least both sides can agree that a bounce and a dip are still ahead of us. We can argue about the magnitude after we get there.
If a person wants a preview of what this looks like, scroll your favorite charting software a little to the left and see what took place this spring. A big crash in February, a sharp rebound from the lows, and a pullback from the rebound’s highs. Predicting the market isn’t hard. That’s because it keeps doing the same thing over and over again. The challenge is getting the timing right.
There are no guarantees in the market and the best we can do trade when the odds are stacked in our favor. This selloff is ripe for a bounce and right now that is the high probability trade. If it doesn’t work out this time, we retrench and try again.
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Jani
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By Jani Ziedins | End of Day Analysis , Free CMU
Free After-Hours Update:
Tuesday was another ugly open for the S&P 500 as overnight weakness in Asia and Europe pressured our markets. We crashed lower at the open and undercut this selloff’s prior lows near 2,710. But rather than trigger another avalanche of defensive selling, that early dip was as bad as it got. Supply of nervous sellers dried up after the first hour of trade and we recovered a majority of the losses by the close. Not very often does a 0.5% loss feel like a good thing, but that is what happened today.
Even though Trump’s tariffs haven’t done much harm to our economy, they are strangling the already weak Asian economies, most notably China. While this is Trump’s desired outcome, global markets are more intertwined than ever and what huts one is felt by everyone else. By taking down China, Trump is indirectly taking down our markets.
The biggest question is what comes next. Is the worst already behind us? Or are we on the verge of another tumble lower? I wish I knew for sure, but the best we can do is figure out the odds and make an intelligent trade based on the most likely outcome. For that, a look back at history is the most logical place to start.
The above chart shows pullbacks in the S&P 500 from all-time highs since January 1950. That gives us nearly 70 years worth of data to analyze.
One of the most notable things is how rare big selloffs really are. Over the last 69 years, only 11 times have prices tumbled more than 15% from the highs. We often think of big crashes like 1987, the Financial Crisis, or the Dot-Com bubble. But those events are exceedingly rare. All the other pullbacks over the last 69 years have been 15% or less. While 15% is a lot, it isn’t terrifying. And even better, all of those under 15% pullbacks were erased within a few months. Small and short. That sounds like something we can live with.
Currently we find ourselves 7% from the highs. Those losses are already behind us and we cannot do anything about them. But we can prepare for what comes next. Assuming we are not on the verge of another Financial Crisis or similar catastrophe, the most likely outcome is a dip smaller than 15%. From current levels, that is another 8%. But that is the worst case. The actual dip will most likely be smaller than 15%.
Over the last 69 years, the S&P 500 has tumbled between 10% and 15% 22 times. That’s about once every three years. Not unheard of, but not common either. The last pullbacks of this size were 15% in 2016 and 12% earlier this year. Are we due for another one? Maybe. But it definitely doesn’t seem like we are overdue given we already had two over the last two years.
More common are pullbacks between 5% and 10%. There have been 36 of these over the last 69 years, meaning these happen every year or two. From 7%, that means we could be as little as 1% or 2% from the bottom. And even better is most of these 15% or smaller pullbacks return to the highs within a few months.
We are down 7% and there is nothing we can do about that. But going forward we have a decent probability of only slipping a little further. And assuming the world doesn’t collapse, worst case is another 8%. While that wouldn’t be any fun, is that really worth panicking over?
The price action has been weak the last few days and that led to today’s weak open. And the market loves double-bottoms, meaning we could see a little more near-term weakness. But what is a little more downside if we will be back at the highs in months month? While I cannot say the bottom is in yet, the odds are definitely lining up behind buying this market, not selling it.
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Jani
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By Jani Ziedins | End of Day Analysis
Free After-Hours Update:
Thursday the S&P 500 tumbled sharply for the first time since last week’s big plunge. The market opened modestly lower, but the selling accelerated after the U.S. Secretary of State pulled out of a big economic summit in Saudi Arabia, heightening tensions between the two nations following the disappearance of a journalist. The market was already on edge after last week’s selloff, and it didn’t take much to push traders back into a selling mood.
But the thing we cannot forget is markets never move in straight lines, especially when emotions are this high. And not only are these sharp back-and-forth moves normal, they are actually part of the healing process. Every fearful seller over the last ten days has been replaced by a confident dip buyer. Out with the weak, in with the strong. While it would be more fun to watch the market zoom right back to the highs, that’s not the way this works. Buying dips are never easy, and that is true this time too.
Early weakness pushed us under 2,800 support. Without a doubt, quite a few traders used this widely followed technical level as a stop-loss. Their autopilot selling pushed the market down even further, triggering the next tranche of stop-losses, adding even more selling pressure. It didn’t take long for regretful owners to start having flashbacks of last week’s plunge and they reactively bailed out “before things got worse”. In a self-fulfilling prophecy, their fearful selling created the very plunge they feared. But by early afternoon, we exhausted the supply of fearful sellers, and prices found support near the 200dma.
There are two ways this story can play out. Bears believe this nine-year economic expansion is on the verge of collapse and it will take the “overvalued” stock market down with it. Blame it on interest rates, trade wars, or downright old age, pick your favorite reason. Or alternately, this is just another one of the 100+ dips and gyrations this nine-year-old bull market weathered on its way higher.
While everyone loves predicting a top, what is more likely, the thing that happens 100+ times, or the thing that only happens once? Remember, bull markets bounce countless times, but they die only once. Could this be the top? Sure. But is it likely? Not even close. The odds are heavily skewed in favor of the continuation, but that never stops people from calling every dip a top.
The thing about this weakness is it is built on the premise that things will get worse. No one is afraid of 3.25% Treasury yields. The are afraid of 3.25% becoming 4.25%, and then 5.25%. Things need to get worse for the worst case scenario to materialize. But on the other hand, if things turn out less bad than feared, prices will rebound. Despite all the naysaying, there are plenty of reasons for stocks to keep going up. Namely, earnings are up 19% this quarter, while stock prices most definitely haven’t kept up with this phenomenal earnings growth. That sounds pretty bullish to me.
Bears need a lot of things to get worse for their thesis to turn into a reality. I just don’t see it happening. Reality is almost always less bad than feared and no doubt this time won’t be any different. People pray for a pullback so they can jump aboard the hot trade they missed, unfortunately, most people are too afraid to buy the dip when the market finally answers their prayers. This game is never easy, but that is what makes it so rewarding when we beat it.
Expect prices to remain volatile as the market comes to terms with recent events. But remember, collapses are brutally quick. The longer we hold last week’s lows, the less likely it is we will undercut them. The most nimble day-traders can buy these intraday dips and sell the intraday bounces. Those of us with a little longer timeframe can buy the larger dips and sell the larger rebounds. The biggest level ahead of us is 2,870 resistance where last week’s plunge started and is likely where this rebound is headed. It won’t be a straight line, but markets that fall down the elevator shaft usually land on a trampoline.
All of this assumes the worst is behind us. All bets are off if we undercut last week’s lows. That tells us buyers are afraid of this market and nothing shatters confidence like screens filled with red. But until then, this rebound is alive and well and believe it or not, we could see new highs before year-end.
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Jani
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By Jani Ziedins | End of Day Analysis
Free After-hours Update:
What a difference a few days makes. Last week the market was collapsing. This week we recovered a big chunk of those losses and things feel significantly better. The only question is if this rebound is the real deal, or just a false bottom on our way lower.
The buying kicked off Tuesday morning when Goldman Sachs and Morgan Stanley reported solid earnings. That was enough to move the conversation away from rising Treasury yields and put traders back in a buying mood. Last week’s selloff lowered expectations and now “not bad” is good enough to send prices higher.
There were a lot of “what ifs” last week asking if rising interest rates and trade war tariffs were going to strangle the economy and crush corporate profits. But if companies continue to hit their numbers the way GS and MS did, expect these “what ifs” to quickly fade from memory. Reality is rarely as bad as feared and it won’t take much to put traders back into a buying mood.
And this week’s dramatic reversal shouldn’t surprise anyone. Markets that fall down the elevator shaft typically land on a trampoline. Last Wednesday I wrote the following after stocks tumbled 3.3%:
“I fear the slow, insidious grind lower. Those are the losses that accumulate when no one is paying attention. What I don’t fear are the big, headline-grabbing down-days. The one that gets everyone’s attention and makes headlines around the world. That’s because those big, flashy days don’t have any substance. As the saying goes, the flame that burns twice as bright only lasts half as long.”
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While it is most certainly premature to claim last week’s selloff is over, the situation is far less scary than it was a few days ago. And that matters a lot when talking about emotion-fueled selloffs. Last week people reflexively sold first, asked questions later. But this week’s bounce gives traders more time to be thoughtful and make rational decisions. Without the pressure of falling prices, most owners will stop overreacting to the fear-mongering headlines.
Risk is a function of height and believe it or not, last week’s dip was actually one of the safest times to buy in months. Prices plunged and impulsive sellers bailed out, but those discounts and turnover in ownership made stocks far more attractive. It certainly didn’t feel that way, but buying dips is never easy. By rule, every dip feels real. If it didn’t, no one would sell and we wouldn’t dip.
We are not out of the woods, but we are close. Hold near 2,800 support through Wednesday’s close and we can say last week’s emotion-filled selloff is over. Even a dip to the 200dma wouldn’t be bad as long as it found support and didn’t trigger a waterfall selloff. Market collapses are breathtakingly quick and holding last week’s lows for four days means cooler heads are prevailing and the impulsive selling is over. Without a doubt, the market could experience another leg lower, but it would take a fresh round of headlines to trigger that next wave of selling.
And while I continue to believe in this market over the medium- and long-term, we should expect volatility to persist over the near-term. If we survive the next few days, then this bounce will continue all the way up to the old highs near 2,870. That is where waterfall selloff started, and the market will likely hit its head back toward 2,800 support. But rather than fear the next dip, that back-and-forth is the healthy way the market recovers from a big scare.
As usual, long-term investors should stick with their positions. More nimble traders can profit from these back-and-forth gyrations. A person that cannot stomach another dip should sell the strength as we approach the old highs and buy the next dip. And if everything goes according to plan, the market will put this bout of indigestion behind it, and we are still on track for a nice rally into year-end. Every dip over the last nine years has been buyable and chances are this one is no different.
If you found this post useful, Follow Me on Twitter so you don’t miss future updates: Follow @crackedmarket
Jani
What’s a good trade worth?
How about avoiding a loss?
For less than $1/day, have analysis like this delivered to your inbox every day during market hours.
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