Monday, March 14, 2016

An Important Market Message Is Now Blaring

I've outlined some very dependable markers of bear turns now developing in our stock market in some recent articles.  I don't like being a such sour puss as I mainly like analyzing individual stocks and seeing them climb. All I ask of the market is to leave my individual stocks alone. A flat, boring market is my favorite. But sometimes there is such a concentration of downside risk, you have to take measures against a market intrusion.

A bear attack is looking likely. One of the many signs is the megaphone. And I don't mean the device the Fed is holding up to its chin to say "everything is fine" to all the investing world.

The message from the central banks is confusing at best. With the US Fed insinuating four rate hikes this year while the rest of the world is scrambling into absurd negative rate territory, one has to wonder just how isolated the US can really be when 60% of the revenue in our major indexes is coming from outside the US.

The megaphone I am referring to is a technical formation. Like all good chart formations, they collect and digest information better than the Fed or anyone, and reflect the historically constant human psychology involved in buying and selling. I listen closely to these messages.

If you look over all the really bad bear markets since 1850, defined as those where the loss was 50% or greater, you have seven of them. Let's start with an early US bad bear, the 1852-1857 sell down. This one doesn't readily pop to mind when "really bad bears" are discussed. But a Wall Street Journal piece written March 6, 2009, three days before the bottom, discussing how '08 stacks up in history, features it prominently. It pointed out that we had to fall way more in 2009 to catch up with the #1 fall in history, 1929-1932 (-83%) and the #2 fall, 1852-1857 (-66%) inflation adjusted. Of course, we didn't do that in March of 2009, so the 1852 bear kept its # 2 all time ranking. So what did this bad one look like? (click on images to enlarge)

That's right - it looked like a megaphone. This technical formation is one that I look for in stocks, because they usually break violently to the upside, when the slope of the megaphone is down and there are positive technical indicators at the low end of the formation. But this is usually after a severe thrashing to the downside.

So #2 was a megaphone, what about #1? Well, sort of. The Crash of 1929 was just that - a crash. A bear market, which transpires over years, is not a crash. Thus the crash of 1987 was not a bear, and the crash in 1929 was not a bear. As I discussed in "A Study In Crashology" 1929 was just a big correction to an over bought condition (like 1987) but the fallout from this in the banking world caused the severe economic downturn, which was a bona fide bear. This was an exception to the rule that bull markets end with a whimper, not a bang. Bulls typically do a gentle roll over into a bear. So, how did all this look?

We see that, after the atypical bang at the end of the 1920s bull market, we had a big, near 50% recovery, and many felt the economy was back on track. Then the market did indeed settle into a megaphone as the banking problems took over heading into the massive bank failures of 1933-34. This diagram shows how the market gyrations get bigger as the megaphone progresses. Each bear market rally was progressively bigger percent wise, like an amplifying sound wave. Technical analysis is all about the message of the market. With these mega-bears, the message seems to get blared louder than normal.

There have been five other lesser bear markets, but of major magnitude, being of a 50% or more decline, since 1850. The next one was The Panic of 1907:

This was a two stage megaphone bear with the years prior to the actual panic included in an overall bear decline. Notice that the market announced the panic well in advance with a megaphone. Then there was the 1937-38 bear, which came after a five year bull in the Depression:

This was another two stage megaphone bear before the final low was put in. If you would have examined a chart in late September, 1937, a clear megaphone was clearly saying, "much more trouble ahead". Probably the next bad bear we think of is 1973-74. The decline was as bad as 2007-08 and the recession was one the worst ever. The recovery was weak and led to "the misery index" being a big election campaign item in the 1980 elections. How did this market look?

This one was not as sharply defined, but the overall pattern was there. What about the bear markets of our time we all know and hate - 2000 and 2007? As I've shown before, they were both of the typical, gentle roll over type. Let's look at 2000:

It was a very sharply defined megaphone with the brutal 2002 meltdown being the last trip down. And 2007?

This was a higher beta megaphone than its predecessors. I would like to point out that the moving average pair I'm showing above is the 140 ema and 200 ema (exponential moving average) which is the best divider I have found between a bull and a bear market. When it consistently acts as support, it's a bull. When it consistently acts as resistance, it's a bear. And it usually resides in the vicinity of the upper reaches of these major megaphones.

That's seven out of seven of the mega-bears in US history that have had this megaphone market message seemingly announcing their arrival. To look at where our current market may be headed, I want to look at probably the best leader index, the small caps of the Russell 2000. This index has been telegraphing the Dow very well lately, and here is how it looks now:

The leading transports (TRANQ) are also showing a nascent megaphone.

I say nascent, because the Dow is just a few percentage points off its high and has a long way down to go if this is indeed a major bear market beginning. The present rally looks like it should run some more to test and retest the moving average pair and the top of the megaphone, maybe to 1140 on the Russell, around 2040 on the SPX. But this may be a good area to lighten long positions that you don't want in a bear market. Don't be like the three monkeys above, be a little worried, take precautions - but be happy.

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