Here’s the thing about these shallow V-shaped pullbacks hallmark of our market since the end of 2012 – everyone knows that they won’t last. As we potentially approach the eleventh straight vertical rally from a shallow pullback, the anticipation for the one that finally fails is once again heightened.
I too fall victim to this anticipation and find myself scrutinizing more measures than I normally do in order to find what might make this one different. The more I look, inevitably the more things I can find. Before pointing out why we are not out of the woods yet, if I take a step back to look at the overall picture (literally displayed below and figuratively) and keep it simple, then there exists little reason to not presume new highs will be made within a couple of weeks.
The rinse and repeat thesis: below are a few bullet points taken from my recent post, Inside the Mechanics of a V-Shaped Reversal on why this pullback is nothing more than just that.
Assuming the pullback is over and in comparison to the last two years of data (with regard to the S&P 500):
- The decline was 4.6% – the average has been 5.1%.
- The pullback lasted 14 days. The average lasted 20 days (note: five have been less than 15 days)
- The pullback began 44 days after the August 7th bottom. The average length between corrections is 54 days.
- We printed a hammer candlestick on Thursday characteristic of a strong bullish reversal.
- We had a follow through day Friday with a gain of 1.1%.
- Financials (XLF) led the way higher with a gain of 1.4% on Friday. GS known as a financial leader gained 2.8%.
In addition to the above we are very close to entering a historically bullish period, both in terms of fourth quarter seasonality as well as the midterm presidential cycle. However, note that we are two to three weeks early on both.
Now here comes the but…. But doesn’t that seem too easy – that we would now rally into the new year clear and free from any more pullbacks or even a deeper correction? Perhaps that type of thinking or complicating things is why in might actually happen. It’s well known that the shallow corrections are partly a result of the bearish sentiment that typically builds up near bottoms as well as the fear of missing out after being programmed to expect new highs rather quickly.
The main takeaway from all the above is that based on recent history the past of least resistance is to new highs and likely in short order. In fact, if you look at the bottom table you will see that except for in one instance (April 2014) the quicker the drop, the quicker the recovery to new highs. 
The rest of the story:
Short-term: In the very short term (and assuming this will be V-bottom #11) there are still things waning on the confirmation of a vertical move higher without one more lower low. In the chart below I have highlighted in green a few examples where a lower low was made after a strong bounce from oversold levels. Indicators that didn’t confirm the bounce would stick include:
- Less than 50% of stocks closing above their 50-day moving average. In the green highlighted examples stocks bounced from oversold levels only to then go back down and make lower lows becoming more oversold. In this most recent example, 41% of stocks are now above their 50-day MA. If that can surpass 50% then chances become much better that the low is in.
- MACD continuing to point down. So far there is no sign of a reversal on a daily chart; however note that the turn is often lagging.
- In all of the highlighted bounces none were able to close above their 50-day EMA. As of Friday we are still below the 50-day EMA.
Intermediate (anecdotally from now until 2015): Listed below are some headwinds that could derail this fourth quarter rally (I’m sure there are plenty more, but I find these most compelling):
1. Psychology/sentiment: Everyone is aware of the historically strong seasonality period and expects a rally into year-end (see this post I wrote about how readily information is changing market dynamics).
2. Discarding the above idea that seasonality being well known is a head-wind, minus another pull-back, the rally is beginning a bit too early. Also, as mentioned above, the average length between corrections is 54 days. If we rally from here till January 1st, it would equate to 91 days (note the pullbacks in October 2013 and April 2014 marked bottoms for 99 and 105 days respectively).
3. Quantitative easing is approaching an end. On the surface this will result in less liquidity. What might be more impactful is the psychological consequences of not believing in the existence of the Bernanke-Yellen put. Remember that exercise you did as a kid where you fall back and trust your friend standing behind you to catch you – yeah well poof, friend not there.
4. The Russel 2000 continues to lag the rest of the market nearing its second 10% correction in six months and more significantly making lower lows since July 1st when it double topped. Below is a chart displaying the SPX, NDX and RUT highlighted with the the 11 corrections. 
5. Each snap back rally results in fewer and fewer stocks participating as you can see below. Notice that 20-day highs continue to make lower lows upon each snap-back rally and subsequent high. Sixty percent of SPX stocks haven’t been at 20-day highs since September 2013 and the last time they were at 50% was in June. 
Main takeaway: I know what you are thinking…. ‘She is basically laying out a scenario where anything can happen.’ I will not deny that. What I am also doing however, is laying out what the path of least resistance is and what I construe to be important to keep a watchful eye on to better your risk/reward going forward. How you use that information will be dependent on what kind of investor or trader you are.
Finally, keep in mind that if Thursday was the bottom then confirmation should present itself within the next day or two of trading based on the short term indicators I highlighted above. Keep your eyes open.
Good luck next week.
For trade analysis, stock picks and option trading check out a subscription.
Vertically Higher or Vertically Challenged – Market Update
Here’s the thing about these shallow V-shaped pullbacks hallmark of our market since the end of 2012 – everyone knows that they won’t last. As we potentially approach the eleventh straight vertical rally from a shallow pullback, the anticipation for the one that finally fails is once again heightened.
I too fall victim to this anticipation and find myself scrutinizing more measures than I normally do in order to find what might make this one different. The more I look, inevitably the more things I can find. Before pointing out why we are not out of the woods yet, if I take a step back to look at the overall picture (literally displayed below and figuratively) and keep it simple, then there exists little reason to not presume new highs will be made within a couple of weeks.
The rinse and repeat thesis: below are a few bullet points taken from my recent post, Inside the Mechanics of a V-Shaped Reversal on why this pullback is nothing more than just that.
Assuming the pullback is over and in comparison to the last two years of data (with regard to the S&P 500):
In addition to the above we are very close to entering a historically bullish period, both in terms of fourth quarter seasonality as well as the midterm presidential cycle. However, note that we are two to three weeks early on both.
Now here comes the but…. But doesn’t that seem too easy – that we would now rally into the new year clear and free from any more pullbacks or even a deeper correction? Perhaps that type of thinking or complicating things is why in might actually happen. It’s well known that the shallow corrections are partly a result of the bearish sentiment that typically builds up near bottoms as well as the fear of missing out after being programmed to expect new highs rather quickly.
The main takeaway from all the above is that based on recent history the past of least resistance is to new highs and likely in short order. In fact, if you look at the bottom table you will see that except for in one instance (April 2014) the quicker the drop, the quicker the recovery to new highs.
The rest of the story:
Short-term: In the very short term (and assuming this will be V-bottom #11) there are still things waning on the confirmation of a vertical move higher without one more lower low. In the chart below I have highlighted in green a few examples where a lower low was made after a strong bounce from oversold levels. Indicators that didn’t confirm the bounce would stick include:
Intermediate (anecdotally from now until 2015): Listed below are some headwinds that could derail this fourth quarter rally (I’m sure there are plenty more, but I find these most compelling):
1. Psychology/sentiment: Everyone is aware of the historically strong seasonality period and expects a rally into year-end (see this post I wrote about how readily information is changing market dynamics).
2. Discarding the above idea that seasonality being well known is a head-wind, minus another pull-back, the rally is beginning a bit too early. Also, as mentioned above, the average length between corrections is 54 days. If we rally from here till January 1st, it would equate to 91 days (note the pullbacks in October 2013 and April 2014 marked bottoms for 99 and 105 days respectively).
3. Quantitative easing is approaching an end. On the surface this will result in less liquidity. What might be more impactful is the psychological consequences of not believing in the existence of the Bernanke-Yellen put. Remember that exercise you did as a kid where you fall back and trust your friend standing behind you to catch you – yeah well poof, friend not there.
4. The Russel 2000 continues to lag the rest of the market nearing its second 10% correction in six months and more significantly making lower lows since July 1st when it double topped. Below is a chart displaying the SPX, NDX and RUT highlighted with the the 11 corrections.
5. Each snap back rally results in fewer and fewer stocks participating as you can see below. Notice that 20-day highs continue to make lower lows upon each snap-back rally and subsequent high. Sixty percent of SPX stocks haven’t been at 20-day highs since September 2013 and the last time they were at 50% was in June.
Main takeaway: I know what you are thinking…. ‘She is basically laying out a scenario where anything can happen.’ I will not deny that. What I am also doing however, is laying out what the path of least resistance is and what I construe to be important to keep a watchful eye on to better your risk/reward going forward. How you use that information will be dependent on what kind of investor or trader you are.
Finally, keep in mind that if Thursday was the bottom then confirmation should present itself within the next day or two of trading based on the short term indicators I highlighted above. Keep your eyes open.
Good luck next week.
For trade analysis, stock picks and option trading check out a subscription.
Share this: