Yes, the Yinzer Analyst has been watching “Edge of Tomorrow” and isn’t afraid to admit that he likes Tom Cruise as an actor and after the week we’ve just had in the markets, I think the movie has a few takeaways for all of us. First Bill Paxton’s character keeps repeating the phrase “It’s a new day people”, and in that he’s right. When the action begins at 9:30 tomorrow, despite what you read on Business Insider (which we love) there’s no way of knowing whether the market will be heading up or down. And if you’re Tom Cruise in that movie, you know it doesn’t really matter. You’re playing a different game altogether because (to steal a line from Battlestar Galactica), “all of this has happened before and all of it will happen again.” If you’re studying market history and enjoy pattern recognition, you’ll know that even if the market changes direction on Monday, the prior uptrend dating back to 2012 has been broken. It’s time to start planning for the market you have and what could be coming next, not the market cycle we just finished.
First, let’s review the daily S&P 500 chart I showed you last week after the strong Wednesday action that broke the downtrend pattern begun on September 19th. The breakout proved to be a false one on Thursday as the S&P gave up all of Wednesday’s gains and then some while plowing into the lower boundary of the downtrend line on heavy volume. Friday’s one day loss on a percentage basis was lower than Thursdays, but only because we fell right to the 200 day MA on even heavier volume and closed at the low of the day. All in all, very weak action as we’re right back to the lows of August 7th and hoping for bounce off the 200 day to keep us from the next support level.
Where is that support? Let’s turn to a daily chart of the S&P 500 showing the uptrend line back to 2012. Using the legs of the uptrend as support lines, we the first line in the sand is at 1800, the second at 1740 and then nothing but air until almost 1350. Could it really get that bad…yes but remember market tops take time to firm so don’t get too itchy to pull the trigger on a major short just yet.
Playing for Position:
How do you set reference points for the S&P to get ready for a pullback? Personally, I’m a huge fan of rules-of-thumb even though I’m aware they’re not totally infallible. Let’s start with the daily chart again to understand why I think we might bounce off the 200 day MA.
- The daily RSI (14) score is very close to the overbought level at 30
- AAII Sentiment still hasn’t turned completely negative. While it is most useful as a contrarian indicator –on a short term basis it can be used for trend confirmation and as of 10.8.14, it’s holding at its historic averages. I’m sure the next weekly reading will show a 4 to 5 point swing from bullish and neutral to bearish.
- We haven’t encountered the 200 day MA yet – the close came on heavy volume but without touching the 200 day MA. Assuming that everyone hasn’t been redoing their algo’s this week, hitting the 200 day could spark a buying frenzy.
So what happens if we do bounce off the 200 day and move higher? What will I be watching then?
First are longer-term chart patterns; even though there’s enough literature about the failings of the 2/10 monthly crossover rule, I find it’s been useful as a reality check if nothing else. If October was to close today, we would be as close to a crossover than any time since 2012 as you’ll see on the first chart below. What happens when the crossover happens? Look at the second monthly chart from 2006-2009 – you can see the crossover in late 2007 and never looked back. Still too short-term for you? Then use the 10 month crossing over the 20 month which happened in early 2008. If nothing else, remember that this is a common tool and even if you don’t use it, lots of other people will. If they start unloading SPY when the 2 crosses over the 10, what do you think will happen next?
If you plan on protecting your portfolio by loading up on inverse SPY or other relevant hedge (I’d stay away from levered inverse unless you plan to watch it daily), I’d look for another more intermediate indicator to use as a signal. I’m currently exploring using the 20 week/50 week crossover a signal for putting on short positions to cover the downside. For the Yinzer Analyst, it’s more about trying to get the overall portfolio performance to zero (market neutral), not trying to generate 4000 bps of spread when/if the market pulls back.
Finally, where would I set a bottom for the market? If we do break the first two levels of support around 1800 then at 1740, there’s nothing but air between 1450 and 1350, which is REASONABLE given how far we’ve come. If any of you followed my recommendation to read Peter Oppenheimer’s piece of P/E cycles, you’d have discovered that when the market enters the “despair phase”, the P/E multiple shrinks typically around 32%. Even after this weeks’ action, the trailing P/E is 18.47 and very much above historical averages. If earnings somehow stayed where they are now, and the P/E fell 32% to 12.54, the S%P 500 fair value would drop to around 1294 representing a 47% drop from Friday’s close.
With that, it’s time to let you get your day underway but come back later this week for our next posts:
“Nowhere to Run Baby-Nowhere to Hide?”
“Nothing to Fear But Deflation Itself”