Is the stock market's rapid decline the start of something much bigger?


Is the stock market’s recent decline the start of a much bigger decline?
You’re probably wondering this question right now.
*Let’s analyze the stock market’s price action by objectively quantifying technical analysis. For the sake of reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

Such a rapid correction

The S&P 500 has fallen more than -9% from an all-time high in less than 30 days (using daily CLOSE $). This is quite a rapid “small correction”.
Such quick downwards reversals from all-time highs are uncommon. The last time this happened was January 2018.

Here are the historical cases in which the S&P fell more than -9% from an all-time high in less than 30 days.

As you can see, this usually led to a medium term rally in the next 3-6 months. The main exception was the 1929 stock market crash, but even that case saw the S&P rise more than 6% the next week.
What’s particularly interesting is that the last time we had 2 of these signals in less than 9 months was April 24, 2000.

  1. We had a signal in February 2018 and now in October 2018.
  2. There was a signal in August 1999 and again in April 2000.

While this sounds scary, it isn’t for medium term traders (we’re not buy and hold investors). The S&P still managed to rally for the next 4+ months before the wheels really came off the bull market.

The stock market’s short term is neither consistently bullish nor bearish

Our recent quantitative market studies have demonstrated that the stock market’s short term outlook (i.e. next 1-4 weeks) is mixed. These studies are neither decisively bullish nor bearish.
Here are 2 slightly short term bearish studies.
The S&P has closed below its 50 weekly moving average for the first time in 2 years (50 weekly = 250 daily). In other words, a long uptrend has ended.
Of course, this brings out all the permabears who are screaming “trendline is broken!!!!!” (never mind the fact that there are just as many false breakouts/breakdowns as there are successful ones).

Here’s what happens next to the S&P 500 when it closes below its 50 weekly moving average for the first time in 2 years. 

As you can see, the stock market tends to bounce 1 week, make a new low the 2nd week, and then rally higher.
We can get more samples by relaxing the study’s parameters.
Here’s what happens next to the S&P 500 when it closes below its 50 weekly moving average for the first time in 1 year.

Once again, you can see that the S&P has a slight tendency to go lower 2 weeks later.
Like the S&P, the Dow Jones Industrial Average has closed below its 50 weekly moving average for the first time in more than 2 years.

Here’s what happens next to the Dow when it closes below its 50 weekly moving average for the first time in 1 year.

You can see that the Dow has an even greater tendency to go lower over the next 2 weeks than the S&P 500. Perhaps this means that the Dow will underperform the S&P over the next few weeks.

Conclusion

Our discretionary outlook remains the same:

  1. The current bull market will peak sometime in Q2 2019.
  2. The medium term remains bullish (i.e. trend for the next 6-9 months). Volatility is extremely high right now. Since volatility is mean-reverting and moves in the opposite direction of the stock market, this is decisively medium term bullish.
  3. The short term is a 50-50 bet right now. Moreover, the stock market will probably remain volatile in the short term (big up and down swings). 
  4. When the stock market’s short term is unclear (as it is most of the time), focus on the medium term. Step back and look at the big picture. Don’t lose yourself in a sea of noise.

Our discretionary outlook is usually, but not always, a reflection of how we’re trading the markets right now. We trade based on our clear, quantitative trading models, such as the Medium-Long Term Model.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
Click here for more market studies

4 comments add yours

  1. Nope. I’m just referring to the fact that the S&P is no longer above its 50 weekly MA

  2. Failed to predict 1
    If you sell, you will probably end up selling into the bottom.
    Even if I’m wrong, waiting for the bounce.
    And just because this correction doesn’t look like the last one, doesn’t mean it’s the end of the world. Most corrections aren’t as quick as the one in February 2018

  3. Matt:
    Troy is correct. If you panic now, you will lose quite a bit of money, ie. 8%, but if the market goes back up you will need almost 12% to get your money back. Nobody can predict the markets. Even Warren Buffett can’t. Even the best hitter in the Major Leagues only bats just above .300, but they all beat their competition and make money, because the batter knows after a slump, he will still bat well again if he doesn’t panic.
    But the owner of this website is playing the odds so they’re in your favor and doing a decent job. Now is not the time to panic and make a decision you will regret later. OTOH, we may fall more in an attempt to stabilize and shake out the weak-hands which have not been shaken out yet.
    You’re also correct that this isn’t the same correction as last time. The end of most bull markets are extremely volatile. So expect this to increase or stay the same as both bulls and bears battle over who wins the soul of the stock market. This is why the corrections and rises are so fierce.
    XLF, the Financials sector is not right in the head. It should be rising with interest rates, however it is not. My guess is that most investors are worried about this being end of the bull market and nobody, this time at least, wants to be left behind when it falls.
    My Liquidity Indicator for the intermediate term continues to fall high off the cliff, down to nearly 12 from almost 60 in the past month. This has never happened before, but I never had this indicator fine-tuned until after the 2008 bear market, so I’m in the dark as well. Remember, I’ll say it again. Nobody knows when the market will fall. Nobody. So don’t panic. Look around you and see what is happening and take it from there. We’re not in a recession.
    OTOH, my Long-term Liquidity indicator is staying steady.
    I’ve never been in this position with this indicator before so I’m not sure whether it will be able to tell me if it works to predict a bear market, so I won’t make a prediction, but it does look like a lot of damage has been done in this market and we will not be heading to new highs any time soon. That’s why the liquidity has been liquidated in the medium term. But I still think New Highs are possible, but it may take a bit longer than we would like. Keep calm. The market has to heal first, the market has to stabilize so the crazy, insane speculators can come in and take a nibble. Then the institutional money has to come in, etc. Stock buybacks can’t overcome all the panic. But sooner or later the market will stop falling and some will see this as a money-making opportunity.
    We’re not in a recession. This damage comes from the last correction where investors were caught. Everyone is second guessing this market
    james

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