Long Winter

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I was lucky enough to be invited to the 18th birthday party of the daughter of a good friend on Saturday. I was pleased to be there because she has endured her own tough journey these past six years that have required digging deep into her own reserves of courage, tenacity and fortitude. Indeed, we all shared the joy of recovery, some though, more enthusiastically than did others. I thought the generous line up of mojito cocktails on the bar to kick things off might have been a tad naïve, but my friend, steady as a rock when the 18 year olds descended on the bar like a herd of wildebeest in a five year drought, said, “don’t worry David, I’ve had a word with the bar staff, half measures only.” Some hours later, as some of the said eighteen year olds were negotiating the dance floor as if they were on the foredeck of a small yacht in a big storm, I couldn’t help thinking that my friend may have underestimated the capacity eighteen year olds to glug half measures of cocktails rendering his cautionary “word to the staff,” somewhat redundant. As the odd 18 year old stumbled out to the bushes or found themselves kneeling over the white porcelain many happy memories of spinning bedrooms came flooding home but I couldn’t help thinking of the market party. Just a wee bit longer and some participants will be reeling around like those 18 year olds, disorientated and numbed to the reality of their predicament.   

FTSE

Equities just had their worst week since May 2012. I don’t think it’s going to improve much. The Dow, Eurostoxx, FTSE, CAC and Dax are now at a loss for 2014. Aim is in are around bear market territory and the Russell 2000 is off 9.5% YTD. We have been following the multi-decade "Jaws of Death" (Megaphone Top) stock market pattern from way back in 2008-9, and warning that when it finishes, a significant bear market will follow. It is possible that we’re at that juncture now and the next bear market and economic collapse has begun. Most people don’t care to contemplate the J of D thing and some have asked me to stop writing about it. Sorry, it’s not going away.

This blog is not a specialist market blog although I do post the odd thing that may be of interest or of importance to a wider audience. Occasionally, I throw up the odd chart but its important to remember that we can play around with charts and often make them, by manipulating the amplitudes, time frames or by using dodgy correlations fit any particular argument. The way to dispell the noise is to look at longer term charts which eradicate distortion. The MACD, Moving Average Convergence Divergence, is a  trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the "signal line", is then plotted on top of the MACD, functioning as a trigger for buy and sell signals. Lets take a look at the MACD for some important equity indices then but on long term monthly charts

Monthly MACD on the S&P

Monthly MACD on the FTSE

Monthly MACD on the EuroStoxx

As you can see they are all in fact gently rolling over. The smart money has left the party and is leaving town.

Weekly S&P

There are a growing list of metrics that would usually indicate a short term bottom is at hand. Those include put/call ratios, elevated volatility, oversold momentum, extended relatives and so on. These metrics though work best in bull trends. In bear trends things do get overdone and extended; then they get more overdone and more extended. Remember, crashes mostly happen from oversold conditions, not overbought ones. 

Point of recognition

Many still view the current decline as a “healthy correction.” I may be wrong but I don’t think it is. The “healthy” view will change when the market experiences a point of collective recognition but we’re not there yet. Until then, this adolescent bear will cheerfully chew up bulls and bears alike until market psychology changes. Last week the Investors Intelligence survey registered bears at 14.1%. By the end of this week the other 85.9% will no doubt be considering their position.

In fact, when we witness the inevitable rally sometime this week being met with aggressive selling, as the bears grow in number, I think people may be shocked with the ferocity of moves. That will mostly because a growing wave of sellers will be met with market liquidity displaying the consistency of dried glue. Bulls need to recover the 1990 level in the S&P for the bears to raise the white flag and that looks like a very big ask. All bears need to establish is a lower high.

Crumble discusses the stock market Jaws of Death pattern

In summary then, in my view best case is a rally, perhaps after more weakness from later this month / early Nov  into the year end then the bear grips the investment complex.  Worst case is we skip the rally bit and plummet from here. Traders should look to short snap back rallies or just go on an extended break for 2 years. Long only investors should be in safety first, low beta defensive mode. The 19th of September, when we got out confirmed Jaws of death pattern, may prove to be a historic date for markets.

It’s going to be a long winter.