Reference Points
SCARY CHARTS
Markets in free fall provide little in the way of guideposts and thus, parking some money on the sidelines is often the only way to prudently reduce unknowns until things settle down.
MILE MARKERS
Corrections and the early stages of a new downtrend never fall into the easy-and-comfortable category and the last three weeks are no exception. When things calms down a bit, the market tends to give us some guideposts to assist in monitoring risk and tweaking allocations. Thankfully, unlike the waterfall chart above, the chart below helps reduce sheep-counting at night.
The look of Wednesday’s candlestick below tells us the session high of 2736 represents an area of possible short-term resistance. The long tail on Monday’s red candlestick tells us the session low of 2603 represents an area of possible support. Thus, we will learn something either way based on how market participants act near those levels in the future.
Use of the upper (UB) and lower bounds (LB) will vary based on how the market behaves in the coming days/weeks (volume, signs of distribution, divergences, moves in the VIX, etc.).
PLANNING FOR THREE MAJOR SCENARIOS
We have to be able to account for three major hypothetical paths for stocks going forward:
A: A sharp bullish push higher
B: A sharp bearish drop
C: Sideways consolidation and whipsaws
The concept of maximum flexibility outlined in this week’s video and in Tuesday’s Short Takes post still applies. Clients can find numerous comments about current market conditions on the CCM Twitter Feed.
Illuminating Charts: Investing Timeframes
IF SEPTEMBER 2018 WAS A MAJOR HIGH
In 2018, we are 39 calendar days from the all-time S&P 500 intraday high that was printed on September 21, 2018. The chart below shows the S&P 500 index 39 calendar days after the highest high that was made on October 11, 2007.
Was it “too late” to take defensive action 39 days after the 2007 major stock market peak? You can decide after looking at the “what happened next?” chart below. Point A in the chart above is the same date as shown via point A in the chart below.
IF TODAY WAS THE LOW
Stocks rallied on Tuesday, October 30, 2018 after three weeks of brutal selling pressure. Human nature being what it is, we all feel like we are missing something if stocks go up for a few days when we have some cash on the sidelines. The chart below shows the date of the 2016 market low after getting off to the worst ten-day start to a new year in stock market history.
In the 2016 chart above, notice how it is not uncommon for the stock market to push higher and then backtrack to retest the prior low, something that may or may not happen in 2018. Was all lost if you did not have 100% of your capital reinvested at point A above? The answer is obviously no when we look at the “what happened next?” chart below. Stocks rallied for over two years.
MORAL OF THE STORY
No one knows how 2018 is going to play out. As noted in this week’s video, a fact-based case can be made for both the big-move-up and big-move-down theories. Typically (not always), if we can step back from the day-to-day swings in price and our emotions, we will have time to prudently get allocated in line with the evidence, regardless if the outcome is wildly bearish, as it was in 2007, or wildly bullish, as it was in 2016.
The vast majority of common investing and trading missteps are related to having a very short-term focus and making changes based on short-term fear. We have navigated to a very reasonable and flexible risk-reward posture in 2018. The market will eventually tip its hand in the “new downtrend” or “correction followed by a new uptrend” direction. If we can shift our focus to the bigger picture, the odds of success will increase significantly. If we remain focused on daily fluctuations and short-term outcomes, the odds of success will decrease significantly.
BUT 2018 IS DIFFERENT FROM BOTH 2007 AND 2016
The purpose here is not to compare 2018 to either historical period; we are simply illustrating basic concepts about trends, timeframes, and patience.
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.
We reviewed all nine historical cases above; the results are shown in the table below.
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.”