I recommend you review my lengthy post from yesterday with a lot of good stats and possibilities, but I thought this topic deserved a separate post.
From Q2 1999 to Q2 2002 covering 3 years, the Dow somewhat traded in a sideways channel of 9700-11300 with piercings on both ends that lasted days and a slowly degrading series of lower lows and lower highs beginning in March 2000. That is a 14% range for 3 years! Even when 9/11/2001 caused a cascade lower well out of the range, it was recovered in about 8 weeks and then maintained for yet another 7 months. Back then SPX was forming a much steeper set of lower lows and lower highs than the Dow, whereas today it seems like the Dow has been doing that since May perhaps due to adding Apple.
A 14% range today would be approximately 1820-2120. I could argue SPX has been in such a range since December 2013. Even with the scenario I painted yesterday, it's not improbable that a spike lower in March/April 2016 to 1650-1750 could recover the 1820-2120 range within a couple months and maintain that for many months longer much like September 2001. If so, we could very well be in another 3 year 14% range from December 2013 to December 2016. You can argue with my numbers and dates a little bit but the point is that staying in a 10-15% range for years is not unprecedented. Personally, I think central banks have made today much different, but the bull market ascent is similar and there is recency bias so it is worth noting.
You might argue that the highs and lows of the Dow 2000-2002 range were tested more frequently. That is true thus far, but there were usually 4-9 months between top/bottom retests. Using today as an analogy, you could argue there was a test of 1820 in April and October 2014 so another test in Aug/Sep/Oct would not really break the analogy. And, you could argue 2120 has been tested several times. In any case, the swings of today have not been as big and frequent as the swings of 2000-2002 but I can envision a similar scenario where SPX trades down to the 1800s or lower into October, rallies back near 2100 by Dec/Jan, retest the 1800s and probably briefly 1650-1750 in March/April and then rallies yet again back to 2000-2100 into mid-to-late 2016.
Of course, I can also envision a steeper decline. The 2007-2009 bear market also had a rounded top like 2000-2002 but with a steeper curve. Both the last 2 bear markets stair-stepped lower in a gradual curve before falling apart and forming Oct/Mar bottoms. I'd expect the same for this bear market. Having said that, if you believe like me that we are still in a secular deflationary bear market with moves exacerbated by the Fed who is nearly out of workable ammunition, then the pattern could be that each cyclical bear market will be rounded but with larger moves and steeper curves each time.
If such a bear market pattern is unfolding, what took 34 months and 50% in 2000-2002 and took 17 months and 58% in 2007-2009 could take 8.5 months and 66% this time around. (the pattern is 34*0.5=17*0.5=8.5 months and 50%+8%=58%+8%=66%) Interestingly, 8.5 months from the May top would be the first week of March 2016 +/-. And, 66% would be SPX 725 or essentially a double bottom. If that isn't scary enough, if that were to occur and the secular bear market then took on the pattern of the rounded, ever-steepening cyclical bear markets, the next rally could be quite large perhaps even retesting the old 1576 high in a H&S formation before collapsing 74% to 400ish. Ouch. That's not a prediction but certainly an interesting scary observation of a potential pattern that could lead to 2 or 3 more ever-worsening bear markets into 2020+. Yikes.
In summary, if you believe in patterns/analogies and if you believe Mr. Market likes to surprise people (these premises somewhat align with the arguments for recency bias and alternation), then I think there are 2 ways to interpret the relationship between the 2000-2002 bear market, 2007-2009 bear market and potential 2015+ bear market.
A. The current bear market will trade mostly sideways through 2016 between 1820 and 2120 with a probable brief piercing as low as 1650-1750 at some point. Perhaps SPX would even briefly pierce the 2135 high although I doubt it and perhaps it will have longer time period between bottom/top retests as compared to 2000-2002 due to lower volatility. Either way, this would be similar but not exactly the same as 2000-2002 and it would alternate with the steeper 2007-2009 bear market.
B. The current bear market will approach the March 2009 lows by March 2016. This would be absolutely catastrophic and perhaps more devastating than the near-50% drop in 2.5 months in late 1929. It would probably entail multiple Black Mondays/Tuesdays/Thursdays like we had in 1929 and 1987.
I must say that when I decided to make this post I was really only looking at years 2000-2002 and Option A. However, once I reviewed years 2007-2009 and noticed a similar but steeper rounded top pattern, Option B came to mind. It sounds pretty crazy...a 66% drop in 8-9 months. Then, I started reviewing all my thoughts, studies and trading over the last 10+ years leading me to Option B. Here are some of them...
1. I believe we are still in a secular bear market and probably just ended a cyclical bull market which makes a 30-90% correction historically feasible
a. Depending on your technical definitions, 1906-1920, 1929-1949, 1966-1982 and 2000-???? can be argued as secular bear markets and 3 of those 4 made new highs along the way, so the year 2007 and 2015 highs don't eliminate today being a secular bear market by some definitions.
b. Previous secular bears lasted 14-20 years. There is no reason to think 2000-2020+ is impossible.
c. Those previous secular bears have occurred in both inflationary and deflationary circumstances with varying degrees and types of central bank intervention. So, even though we know the current Fed's actions are unprecedented in terms of $$, % and time-length as they try to defy nature and math, they are unlikely to change the result much.
d. 3 of the 4 previous secular bear markets made new lows anywhere from 9 to 16 years after they started and the one that didn't in 1929 had several significant retracements for 10 years after the initial 1932 low. So, a retest or even break of 667 would not be historically unheard of.
e. The 4 previous secular bear market have reached 50%+ corrections many times including at least 2 more than 66%, so a 66% correction would be reasonable for a secular crash. The 2000 SPX secular bear market has already had a 50% and 58% correction with multi-month moves of 30%+ on numerous occasions as well. The 1929-1932 cyclical bear market had 7 multi-month downtrends exceeding 30% with the first and last being the largest, 49% and 55% respectively. Commodities are known for finishing with flushes like that but stocks are not immune.
2. A 66% loss can reasonably happen in 9 months (May 2015 to March 2016). In year 2008, SPX fell 54% from 1440 to 667 in less than 10 months including a 36% drop in just over 1 month. The Dow fell 49% in 2.5 months in 1929 and it fell about 66% in 8 months from November 1931 to July 1932. SPX fell 38% in 7 months in 1974 (March to October). A 66% drop in 9 months can and will happen again at some point.
3. In terms of patterns, most of you have seen the Dow (or even loosely SPX) megaphone patterns since year 2000. The pattern projection is for price to fall to the lower boundary again below 667. So, SPX 725 is certainly on the way. Maybe a bounce near there to sucker the double-bottom folks into losses before the real bottom.
4. In terms of EW, my custom dRSI indicator built over many months during the last bear market using studies back to the 1800s determined that year 2000 completed a wave 3 of 3 even breaking the strength of the 1929 hype. I proposed that the 1929 and 1966 bear markets completed wave 1-2-1-2 of some degree (or possibly a 1-2-3-4 of lower degree) based on dRSI. Even if you argue those secular bear markets were not 16-20 years as some propose, many Elliotticians argue that wave 4s are generally longer in time and more complex than wave 2s although alternation is a consideration. No matter how you look at it, a 16-20+ year secular bear market is not unreasonable. When you look at the Dow from 1900 in log scale as you should, the 1987-1999 slope and ascent stand out as the heart of a wave 3 even compared to the 1950s AND the current secular bear market looks tiny compared to 1929-1932 and even noticeably smaller than the 1970s bear, so there is room for the current bear to make new lows and still look easily proportional as a wave 4 equal or smaller than the corresponding wave 2s. Unfortunately, if I am correct in my dRSI hypotheses, the USA likely had wave 2s even prior to 1929 going back to the 1700s and we are now in the early stages of a bunch of nested wave 4s and wave 5s possibly for the next 100+ years as our dominance is chipped away. The '80s and '90s were the best it will ever get in the stock market and probably our economy too but we'll still have spurts of greatness. :)
5. Mr. Market likes to fool as many people as possible and take money. Not many people are expecting 667 to be retested and most of those who do will be caught off guard if it happens in 9 months (only 6+ months from today). 90%+ of people will lose money. People have been lured into years and years of low volatility. Those who remember the last 2 bear markets intimately may just choose to sit the next year or two out in which case the market could get even thinner and more volatile especially as record leverage and margin get unwound. Central banks don't have the workable ammunition they once had and I don't think the laws of nature will allow them to double down "successfully" any longer especially as numerous local and national governments sit on the bring of disaster. Excess must be allowed to truly unwind at some point and single-digit PEs, affordable housing & college with minimal debt, minimal leverage and a reasonable return of interest would be my expectations for that unwind to be done.
6. I could rattle off a ton of other technical and fundamental problems that suggest our economy has been built on a house of cards or quicksand, but you get the picture. Housing is probably the biggest indicator I can remember seeing that was WAY off the charts in 2006 and never fully allowed to correct. Since then, student loans, auto loans, more stupid home loans recently, corporate buybacks, empty emerging market cities and corporations, mandated health care, all-time record margin debt and a bunch of other crap has been allowed to fester and grow to the point we are going into septic shock soon. Anyway, I'll move on.
So, I give Option B pretty good odds now that I think about it. In any case, there is a strong argument to be made about a stock market drop into October and again into March, so I guess it's just a matter of degree. But, it could affect your trading strategy. If SPX will fall to 725 by March, it could even be dangerous for day-traders to go long. Let's say we rally to 2040 +/- 20 in the coming days as I suspect. Then, SPX will fall from 2040 to 725 (64%) in 6 months. That is 11% per month and 0.5% per trading day. Of course, the same nearly happened in reverse at the start of the last 2 bull markets, so don't think it's not possible.
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Yesterday, I outlined what I expect tomorrow depending on whether SPX rallies from 1971 or falls further to the 1950s or 1920s or even a 1987-style collapse. My favorite scenario would be a drop to the 1950s or 1920s, because my stats show near-100% odds that we'd then get a huge rally of 50-100+ points which I plan to profit from. And, that would also make it even more likely that the next lower low will reach the 1920s or 1870-1895. I see futures opened about 10 points down but I've learned over many years they can swing wildly many percent before the open in volatile situations so that tells me nothing yet. However, based on Option B, I have a strategy to join the millionaire club that I will try. Wish me luck. I will post that strategy separately. Good fortune.
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