Market Breadth Shows Signs Of Life
MARKET ACTION NEAR 50% RETRACEMENT MAY BE TELLING
The S&P 500 closed Tuesday near the 50% retracement of the A to B decline shown in the chart below.
Something very similar happened after the initial drop from the major stock market highs made in March 2000 and October 2007. In each case, the market dropped a long way, had a very sharp rally, and moved back near the 50% retracement. In the 2000-01 case and 2007-08 cases, the S&P 500 reversed soon thereafter and resumed the bear market. The 2000-01 and 2007-08 cases are covered in detail in this thread of tweets. Therefore, it is prudent in 2020 to see how the market acts near a very similar 50% retracement level. Our current allocations reflect the forms of bullish improvement we have in hand and they reflect numerous forms of still-concerning evidence that we have in hand.
LONGER-TERM ODDS CONTINUE TO IMPROVE
As shown in the chart below, it is relatively rare for the percent of NASDAQ stocks above their 150-day moving average to move from the blue line to the green line. The blue line represents a rare oversold level and a move back to the green line can be thought of as a breadth thrust setup. Breadth thrusts typically occur when market participants are becoming more constructive on the long-term outlook for stocks and the economy. Notice how past oversold readings have occurred near favorable long-term risk-reward levels for the S&P 500 (bottom of chart).
The table below shows S&P 500 performance after similar breadth thrust setups in the percent of NASDAQ stocks greater than their 150-day moving average. The data below, based on something that occurred over the past 15 trading days, helps us keep an open mind about much better than expected long-term outcomes in the stock market. If you know market history, 2002, 2009, 2011, 2016, and 2018 all fall into the “major low” category. 2020 is a unique case and will follow a unique path.
The study above is based on a setup. Setups require follow through; something that may or may not happen in 2020. It is very important to understand what setup means. A setup tells us to pay attention and look for further confirmation signals. If the confirmation signals do not materialize, we will learn something in that case as well.
HISTORY SAYS PULLBACK WOULD NOT BE SHOCKING
Is it possible the stock market continues to rise and never looks back? Yes, it is possible based on the 2016 and 2019 cases shown in the table below. On April 14, 2020, the percent of NASDAQ stocks that had recaptured their 150-day moving average stood at 22.39%. In the five historical cases, how much backtracking occurred in the S&P 500 from the dates shown below associated with similar moves in market breadth? The maximum drawdown was 9.60%. The median drawdown was 4.30% and the average drawdown was 4.11%.
If a similar giveback occurred in the next six months, what would that hypothetically look like on a chart of the S&P 500? The answer is shown below.
BREADTH TODAY vs. 2018-2019 THRUST
As of this writing, 2020 market breadth has not demonstrated the same extremely confident shift that occurred in early 2019. Thus far, the breadth signals are more muted, but we have seen enough to respect the historical message in similar shifts. This week’s video opened with another bullish-leaning occurrence related to 2020 market breadth. The video also covered impressive moves in market breadth that occurred in bear markets and before the market’s final low was in place.
SOME MEASURES STILL LOOKING FOR IMPROVEMENT
There are numerous ways to measure and track stock market breadth. Many breadth readings in 2020 still have some room for improvement. For example, April 14 was 15 trading days from the March 23, 2020 low in the S&P 500. The percentage of NASDAQ stocks above their 50-day moving average reached 51% in the first 15 trading days after the major low in 2002; after the 2009 low, the 15-trading day peak was roughly 65%. Thus far, the max 15-trading-day level in 2020 is quite a bit lower at 31%. Like many breadth indicators tracked by the CCM Market Model, we can learn something about bull/bear odds by monitoring the percentage of NASDAQ stocks > 50-day moving average in the coming days and weeks.
NO PREDICTIONS, NO FORECASTING
Not much has changed this week in terms of having a mixed hard data picture; some really good things have happened, and some concerning data points and observable evidence tell us the market has not shifted into a fully-accepting risk-on stance. For example, banks, junk bonds, transportation stocks, and small caps have continued to walk forward in a somewhat tepid manner. Therefore, the four market scenarios below continue to provide a framework for prudent contingency planning:
ONE: Low is in and stocks continue to rise rapidly.
TWO: The market will remain in a wide trading range.
THREE: A typical retest of the March 23 low is coming soon.
FOUR: An atypical retest with a significantly lower low lies ahead.
Unless you believe you can predict the future with 100% certainty (something we all know is not possible), it is prudent to have a mixed allocation currently that allows you a migration path to handle all four scenarios. Allocation shifts we have made in recent weeks reflect improving bullish odds and decreasing bearish odds based on data today relative to data 15 trading days ago.
Given the shifts in market breadth (constructive) and bearish reversals near the 50% retracements in 2001/2008, we will continue to see how the 2020 data evolves while remaining open to and prepared for a wide range of outcomes. Additional forms of positive and concerning evidence can be found on the CCM Twitter Feed.
This post is written for clients of Ciovacco Capital Management and describes our approach in generic terms. It is provided to assist clients with basic concepts, rather than specific strategies or levels. The same terms of use disclaimers used in our weekly videos apply to all Short Takes posts and tweets on the CCM Twitter Feed, including the text and images above.
Long-Term Bullish Signals, Intermediate-Term Concerns, and Realistic Expectations
BREADTH STUDIES, ECONOMIC ANALYSIS, IMPACT OF FED & VIRUS
Market Scenarios
The four market scenarios below provide a framework for prudent contingency planning:
ONE: Low is in and stocks continue to rise rapidly.
TWO: The market will remain in a wide trading range.
THREE: A typical retest of the March 23 low is coming soon.
FOUR: An atypical retest with a significantly lower low lies ahead.
Unless you believe you can predict the future with 100% certainty (something we all know is not possible), it is prudent to have a mixed allocation currently that allows you a migration path to handle all four scenarios.
Historically, significant declines are typically (not always) followed by a retest of the prior low. We just experienced a rare and significant decline that was accompanied by a weekly RSI close below 22.
To provide a scenario-specific framework walking forward, we found every case when weekly RSI dropped below 22 since the S&P 500’s inception in 1957. In the six historical cases, the median rally following low one was 14%. All six cases featured some type of retest after the sharp post-low-one rally. The table below provides a summary of the most relevant points. The median outcome was a retest of low one that dropped 2.20% below low one. The second column shows two of the six historical cases made a higher low relative to low one. Low one is the initial “high fear low” and low two is the retest low or “lower fear low”.
Putting the results on hypothetical 2020 graphs helps highlight the main takeaways. In the graph below, the horizontal lines show hypothetical retest lows based on five of the six historical weekly RSI cases. While it may sound counter intuitive since we have some exposure to stock ETFs, the best case scenario is for the market to drop significantly again and make a stand somewhere near the areas denoted by the horizontal lines, allowing us to redeploy cash at lower prices. Having some exposure to stocks prior to a retest also increases the odds we can get close to fully invested near the retest low. Moving from 100% cash to 100% invested near the retest low is a difficult risk-management and psychological proposition. Sitting in 100% cash today also makes it nearly impossible to effectively deal with scenario one described in the opening paragraph.
The graph below includes the 2008 case. If stocks drop back toward the prior low and we are unable to check the “we expect to see this on a successful retest” boxes, then we must be prepared to account for a significantly lower low relative to the March 23, 2020 low. As noted on April 6, recent market action has reduced (not eliminated) the odds of a sustained drop significantly below 2,100 on the S&P 500.
THERE IS NO MARKET LAW REQUIRING A RETEST OF A LOW
It is easy to say “the market has to retest the low”. The same argument was made during the entire calendar year 2019. Contingency plans must account for even lower probability scenarios. The probability of the “no retest” outcome is never zero.
PLANNING SEVERAL MOVES IN ADVANCE
Decisions that we make in the present day must consider all four major market scenarios and they must do so in the context of the longer-term goal, which is to remain in step with the market’s primary trend. It is very easy in the current environment to get hyper-focused on our account balance intraday. It is helpful to think about your entire portfolio when the market is dropping, rather than focusing on the daily decline in a few positions. If you have 10% exposure to the stock market and the market drops 10%, the impact on your account is only 1%. The table below can assist with thinking about your whole portfolio during high volatility periods.
Our goal is not to minimize intraday fluctuations. Our ultimate goal is to get to the other side of this event. The reward for those who remained focused on the ultimate goal in the six similar oversold RSI cases was outstanding. The table below shows S&P 500 performance following the six similar weekly RSI cases discussed above. Our timeframe is not the next two trading hours, the next two weeks, nor the next two months. The table below helps us to keep “the other side” in mind during periods of high volatility and stress.
This post is written for clients of Ciovacco Capital Management and describes our approach in generic terms. It is provided to assist clients with basic concepts, rather than specific strategies or levels. The same terms of use disclaimers used in our weekly videos apply to all Short Takes posts and tweets on the CCM Twitter Feed, including the text and images above.