SHORT TAKES
This week's video covers numerous topics and markets, including the selloff in bonds, the impact on stocks, comparisons to 2000 and 2007 major tops, status of multiple-year breakouts, asset class behavior near tops and bottoms, tech stocks, industrial stocks, S&P 500, Value Line Geometric Index, and the broad NYSE Composite Stock Index. The video covers over 40 charts.
THURSDAY UPDATE: Please see CCM Twitter feed for latest comments.
The concepts below are vitally important in order for us to successfully navigate the volatile and emotionally-draining financial markets.
"Volatility to ignore" vs. "volatility to respect" has nothing to do with % declines in the market; it is based on data about the market's long-term health.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
If the data says the odds favor higher highs (and higher profits) = volatility to ignore.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
If the data says the odds are mixed or favoring lower lows = volatility to respect.
The objective is to stay with the primary trend and make money, rather than avoid all volatility.
If your primary objective is to avoid market swings, drawdowns, volatility, and stress, it is going to be very difficult to stay invested and participate in very large market moves that can occur over many years.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
It is not possible to build a model and change the simple fact that volatility is a normal part of all markets.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
The first step in developing a trading system or investment model is to understand how markets and human emotions operate in the real world.
The real world has volatility, emotions, an intense human desire to be right, ego, fear of loss, fear of missing out, bias, etc.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
All of this (and more) needs to be considered when building a trading system or model.#Markets $SPX
The nature of primary trends, and normal and to be expected countertrend moves, tell us that if we are invested with the long-term primary trend:
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
We should feel good.
We should feel bad.
We should feel good.
We should feel bad.
Repeat until primary trend ends.
Therefore, we should not be surprised when we feel bad during normal and to be expected countertrend moves; it is the nature of the beast.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
Realistic expectations are key to success. Unrealistic expectations will lead to stress, emotional swings, and disappointing results.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
Market fractals tell us the concepts below apply to all timeframes: one trading hour has primary and countertrend moves; the same can be said for a trading day, week, month, year, decade.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
We should feel good.
We should feel bad.
We should feel good.
We should feel bad.
If we knew the market was going to fall 10% over two weeks, and then rally to a new all-time high over the next six weeks...
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
...should that be treated the same as a 10% decline that does not see a new high for 2 years; and during the two years bonds gain 8%?
Time & Opportunity
Understanding in advance and reminding ourselves (a) countertrend moves are normal, (b) it is not possible to feel good all the time, allows us to conserve emotional/mental capital.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
When emotional/mental capital reserves are low, the odds of errors/poor decision making increase.
Any input that is not related to your process is drawing down on limited emotional/mental reserves.
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
Reserve Drainers:
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
Debating about markets, politics, economic outlook.
Trying to read every bullish/bearish article.
Trying to review every chart/input.
Listening to evey talking head.
The market is paying attention to all of it. We handle it by paying attention to the market.
Game plan today is the same as every day:
— Chris Ciovacco (@CiovaccoCapital) February 7, 2018
Are we allocated prudently based on the facts in hand?
If yes, choose "do nothing" alternative.
If no, make an adjustment to get back in line with the hard data.
No predictions, no forecasting. #Evidence #Probabilities #Markets
In a separate post, we compared 2018 to numerous plunge periods in history (1955, 1987, 1998, 2000, 2007, 2011, and 2015).
Having studied markets for years, we can confidently say the data we have in hand in 2018, on multiple timeframes, looks almost nothing like the data we had in hand before plunges in 2000 and 2007. The most similar periods are 1955, 1987, 1998, 2011, and 2015.
Therefore, it might be helpful to better understand what happened after the plunge was over in the five similar cases. Did stocks tank or did they find their footing and produce positive returns. The data speaks for itself.
Is it possible stocks continue to tank over the next two years? Yes, anything is possible, but it is not probable based on the historical data and 2018 data. We will continue to take it day by day, with an open mind about any and all outcomes, from wildly bearish to outrageously bullish. If the hard data says we need to take defensive action, we will not hesitate. If the hard data says we should be patient and sit tight, we will choose the "do nothing" alternative.
The charts can be found here. Anything can happen in the markets, including very low probability outcomes, but it still makes sense to understand the probability of good things happening relative to the probability of bad things happening. It is best to maintain a flexible, unbiased, and open mind, which allows us to prudently interpret new facts over time.
While they seem unprecedented and/or unnerving while they are occurring, market dislocations are not all that rare. Experience says those that remain cool, calm, and collected with their eye on data from multiple timeframes have the greatest chance of being satisfied with their results looking back six months from now.
“I learned at sea virtually all situations can be handled as long as the presence of mind is maintained.”
Josh Waitzkin, Chess Champion, The Art Of Learning
Therefore, we reviewed numerous cases on Monday night and decided to focus on the eight below.
The set of charts below show the S&P 500's pre-plunge profile, allowing us to better understand the odds of a new bear market/prolonged correction.
The moving averages on each chart range from the 20-day (blue) to the 200-day (orange). The 1955 case looked good from a trend and conviction perspective. Price was above all the MAs, blue, the fastest moving average, remained on top looking back seven months, and the slopes of all the MAs were positive. All of that said "the market looks relatively healthy on multiple timeframes".
The 1987 chart had quite a bit more evidence of a waning trend relative to 1955. The chart below is as of October 13 allowing us to see the market's profile before the Black Monday plunge, which occurred on October 19, 1987.
Like 1987, there were several signs of waning bullish trend in 1998.
The market was a volatile, indecisive mess before tanking in September 2000. The 2000 profile was much worse than 1955.
Sideways price action speaks to indecisiveness; stocks went sideways for nine months before tanking in December 2007. Compare the look of the 2007 chart below to the 1955 chart above - 1955 was making a series of higher highs and higher lows (bullish trend) - the chart below went absolutely nowhere for nine months (indecisive behavior).
The 2011 chart was a mess before the market plunged. We can draw horizontal lines and hit price many times in 2011; not the case in the 1955 example.
The market was saying "pay closer attention" for six months before the 2015 plunge. In the 1955 chart, the moving averages cover a wide range on the price chart (a sign of a strong and sustainable trend). The 2015 chart below features a tight MA cluster, which said "a big move could be coming".
On Friday, January 26, 2018 the S&P 500 closed at a new all-time high. Trends from short (20-day) to long (200-day) were all constructive. The market had a full-bore bullish look with price above all the MAs, blue, the fastest moving average, on top, and the slope of all the MAs were positive (aka bullish). The market had not been moving sideways, but rather making a series of higher highs.
When we look at trends on multiple timeframes, it helps us understand how market participants are interpreting all fundamental and technical data looking out a few days to a few years. It is pretty easy to see the charts from 1987, 1998, 2000, 2007, 2011, and 2015 have numerous forms of waning trend evidence, which is indicative of waning confidence in the economy and markets. The two charts with the strongest and most sustainable-looking trends are 1955 and 2018. The 2018 chart shares almost nothing with the 1987, 1998, 2000, 2007, 2011, and 2015 charts.
It is extremely rare for markets to have a dislocation event or plunge with a profile as strong as the one that was present on January 26, 2018. Since markets can do anything at anytime, meaning even very low probability outcomes can occur, we always remain open to all outcomes, from extremely bullish to extremely bearish. If you know your market history, you know bad things happened next in 1987, 1998, 2000, 2007, 2011, and 2015.
In the 1955 case, stocks experienced a sharp 6.8% correction and then resumed their well-defined bullish trend, tacking on an additional 42.3% over the next 510 calendar days. If you are keeping score at home, the S&P 500's correction in 2018, as of Monday's close, was 7.8% (similar to 1955). In order to compare apples to apples, we need to compare 6.8% to 2018 as of Tuesday's close (rather than intraday Tuesday).
History says the stronger the trend when the dislocation occurs, the higher the odds the dislocation will be sharp, but relatively short-lived. Said another way, the stronger the profile before the dislocation, the higher the odds the plunge will be followed by gains and eventually a new high in stocks.
For example, if we remove the two strongest cases 1955 and 2018, the next two strongest profiles were 1987 and 1998; in both cases patient and rational investors were rewarded with new highs (and much higher profits). Conversely, the two weakest profiles were 2000 and 2007; the present day looks nothing like the periods from 2000 and 2007 shown above.
Our approach remains the same; if the hard data calls for action, we will take action. If you ask anyone who has been through a difficult situation in the markets, they will tell you if you want to increase your odds of poor results looking back after six months, ignore the hard data, break your discipline, and make short-term/emotionally-based decisions. Experience says make decisions based on the weight of the evidence on multiple timeframes, stay aligned with the hard data, stick to your discipline, and make logical decisions.
The second part of this analysis can be found in this S&P 500 performance after waterfall declines post.
