First, the good news…

The good news

I read with great interest a recent report from my favorite market statistician, Jason Goepfert (www.sentimentrader.com). Jason points out that the Dow Jones Industrial Average—which we have data on going back to the late 1800’s, has seen only 26 times where the market has experienced similar conditions as of late. That is, 3 months or longer of no corrections, followed by an eventual 10% correction, and then a 5% + rebound in the next 5 (or less) days.  When one of these moves occur, such the recent selloff and last week’s 5%+ rebound, it leads to some upside.   Under such conditions – markets tend to follow up with multi-month upside. That’s the good news.

The bad news

The bad news is that such a pattern often leads into severe bear markets. The market typically succumbs to the bears after 3-6 months of upside. Statistically, the market was (on average) net negative one year later after the 26 occurrences of this pattern.

This ties in well to my theory that we are in the final stages of the current bull market. Call it “wave 5” aka Elliott Wave Theory, or just plain old business cycles – it is likely that the current bull market is growing long in the tooth. I’ve discussed this potential on this blog a few times, including last October.

Above is a monthly (big picture) chart of the S&P 500 with the 4 phases of each market numerated on the chart. I have covered how the 4 phases of a market work on this blog – and in my book Sideways. According to how I view the cycles of the market (aka the 4 phases), we are still in “Phase 2 bull market” mode. A break of the 200 day (10 month) SMA and a lower low on the chart can suggest the end of the bull market. Its best to confirm if it stays below that level for the better part of the month. Exceptions to this rule – and even outright head fakes – can occur.  The recent bull faked us out in 2010 and 2011. But most of the time it’s a pretty good way of staying in during the bull markets and getting out before too much carnage ravages your portfolio.

The bottom line: it ain’t over until its over.

10 Comments

  • How does one reduce their portfolio if this occurs? For example, would we sell 1/2 of each holding or completely sell individual holdings? Do you have some advise on this?

    Reply
    • Vallie–never sell out completely, as nobody knows with any absolute certainty an outcome – If the market breaks, then the first thing I typically do is reduce beta by selling high beta stocks. I will usually keep my low to mid beta stocks. You get beta readings off of most of the exchanges websites for individual stocks. I do it in stages, legging out as markets fall. I have in the past been about 50% cash during market meltdowns.

      Reply
  • Keith – Interesting perspectives as always. If I read this and your previous post about the Bear-0-Meter being very bullish in the short term, I think I understand that short term prospects are good, but be super wary of a rollover that tests the 200 day MA again. Is that a fair summary?
    John P

    Reply
    • Yes John–basically you don’t want to see the 200 day SMA penetrated for too long–I use a rule of 3–meaning 3 weeks on the weekly chart. It not the holy grail of indicators, but its a good indicator that things are more serious if that MA is broken for too long

      Reply
    • Thats a big long MA. You must be very bearish. I cant say I’m as pessimistic right now Dave. You know I am bearish after an initial bump – but I dont think we’re going to see the big move right now. Give it a few months, me thinks.
      A test of the 200 day (10 month) may happen, or not. As discussed, complex bottoms – where the prior low which landed near the 200 day MA at 2500-ish is tested. Tests of 1,2,3 times are frequent. But its a long way down from there to the 20 month MA!

      Reply
  • Hi Keith,

    I’m confused as what to do right now. Because I don’t want to use U.S dollars, I’m limited to Canadian dollar ETF(s) and so, for international diversification, I’m looking at ZDH, ZLD, ZEQ, ZDM. They look quite different technically. ZDM looks best, clearly about its 200 day moving average. ZLD is right on it. ZDH and ZEQ are clearly below it. Will those last two catch-up and the whole market get back to old highs? Or will ZDM go back down through its average and then all of those ETF(s) will make a lower high? That would make their weekly charts quite grim looking.

    What to do, what to do,
    Matt

    Reply
  • I appreciate your direction here, Keith, but am confused about one point – isn’t the 200 days closer to 7 moths than to 10?

    Reply
    • 200 business days at 5 days a week = 40 weeks. Averaging 4 weeks per month is about 10 months
      You could make arguments for months like Feb with less weeks or March with more weeks …but I average 4 weeks per month to keep it simple and bring it to 10 months
      Its actually more like 9 months but the 10 month MA makes it a little slower and bigger picture so i go with that

      Reply

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