More Pain Ahead For Stocks?

CORRECTIONS CAN BE PAINFUL

The distinction between corrections (10% drawdown) and bear markets (20% drawdown) is somewhat arbitrary. Let’s assume we knew with 100% certainty the current sharp pullback was a correction. Does that mean the pain is almost over in 2018 or could there reasonably be more downside?

We studied the nine historical cases highlighted in an October 26, 2018 Wall Street Journal article entitled “Has The Bear Market Arrived? History Says Not”. From the @WSJ article:

“The S&P 500 is down 9.1% over the past month, and the broader MSCI All Country World has lost 8.5%. There is no clear explanation: Investors have blamed tighter monetary policy, trade tensions and weakening economic indicators outside of the U.S., but these factors have been present all year. “

“An analysis by U.S. investment bank Morgan Stanley , surveying the past 65 years of the S&P 500 and the past 27 years of the MSCI All Country World, finds that sharp initial drops are hallmarks of run-of-the-mill corrections, defined by declines of between 10% and 20% in equity prices.”

You can make an argument the @WSJ image below and the fact the article refers to most of the similar historical cases as “run of the mill corrections” implies the pain in 2018 might be over very soon.

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We reviewed all nine historical cases above; the results are shown in the table below.

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The S&P 500’s recent intraday all-time high was printed on September 21, 2018 at 2940.91. Therefore, if the 2018 market experienced the average decline above, the S&P 500 would hypothetically find a low on January 4, 2019 at a level of 2382. The S&P 500 closed Monday at 2641, or 259 points above the hypothetical average bottom of 2382. Said another way, if the market experienced the average high to low decline in the nine similar historical cases above, the S&P 500 would fall an additional 9.78% from Monday’s close.

HOW DOES ALL THIS HELP US?

The table above will not impact our process in any way. The range of declines in the nine historical cases of -10.59% to -37.27% helps us keep an open mind about a wide range of outcomes from “we could be near a bottom” to “this could still get really ugly.”

Market Needs To Prove It

MONDAY’S SESSION

The S&P 500 got off to an impressive start Monday, at one point posting a gain of 48 points. Once again selling conviction picked up producing another ugly set of daily candlesticks.

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Early in the session, today’s high exceeded Friday’s, which is what we want to see (compare A to 1 ). Then, the market reversed sharply and dropped below Friday’s low (compare B to 2), which adds to the concerns we had at the end of last week. Price was also rejected near 2700.

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As shown in the chart below, the market also recaptured the 61.8% retracement intraday, and then closed well below it (the attempt failed).

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We have the same concerning “failed attempt” look on the daily chart of the NASDAQ.

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The market needs to show us something that looks like a bottoming formation. Rather than getting that today, we got a concerning reversal near key areas. The data says “inflection point”. It is difficult to make the claim the market is siding with the “big push higher” case given the shorter-term evidence we have in hand as of today’s close. To the contrary, the charts in their present form still say “be careful out there”.

As noted on Twitter and in this week’s video, it is extremely important we remain highly flexible in the current inflection point environment. We can always buy back once the data starts to show some meaningful improvement. Given the market’s still vulnerable look, our cash positions help mitigate the “another sharp leg down” risks that have yet to be cleared. They may be cleared soon, but we have little-to-no evidence in hand at this point. We will continue to take it day by day.

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