Signs Of A Stock Market Correction Developing (ZT)

TigerFox

James A. Kostohryz, JK Market Insights (1,089 clicks)
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Signs Of A Stock Market Correction Developing
May. 8, 2015 7:50 AM ET  |  53 comments  |  About: SPDR S&P 500 Trust ETF (SPY), Includes: DIA, QQQ
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary

I have previously noted that the risk of a 10-20% stock market correction before the end of July is unusually high due to fundamental reasons.
In this article, I document short-term, intermediate-term and long-term bearish technical trend reversal patterns that are developing in the S&P 500 right now, supporting the correction risk thesis.
Technical analysis, at its best, must be understood as providing probabilistic hints; not definitive signals.
Signs Of A Stock Market Correction Developing

In my latest radio interview, I explained from a fundamental perspective why the risk of a 10-20% correction between now and the end of July in the major stock market indices such as the S&P 500 (NYSEARCA:SPY), Dow Jones Industrial Average (NYSEARCA:DIA) and Nasdaq (NASDAQQQ) is relatively high. I had previously outlined these reasons here on Seeking Alpha rather extensively. These fundamental risks include the current economic slowdown, the consequences of a rising US dollar for US economic growth and corporate earnings, risks related to Fed tightening, stretched stock market valuations and various geopolitical risks, among others.

In the present article I will provide an analysis of the evolution of the price action of the aggregate stock market as represented by the S&P 500 - a type of analysis known as "technical analysis". My goal in this article is not only to alert readers to these developing technical patterns, but to explain how technical analysis more generally can be useful for analyzing fundamental factors, and vice versa. As an example of this, in this article, I will relate certain developing price patterns to the risks of a significant stock market correction, as discussed in my previous work.

The Nature of Stock Market Corrections

As I explained in a separate report, bear market declines of 20% or more can be predicted with a high degree of accuracy using fundamental data alone. In particular, the prospect of a business cycle recession is by far the most important predictor of a bear market.

However, corrections of more than 10% but less than 20% are much more difficult to predict on the basis of fundamental analysis. The reason for this is logical: Outside of severe business cycle risk, there is really no fundamental reason for a significant decline of 10% or more in aggregate stock prices to be triggered.

Almost by definition, mere stock market pullbacks would probably never devolve into significant corrections of more than 10% unless forces other than fundamentals were significantly at play. Indeed, my historical study of the stock market suggests that technical conditions play an outsized role in such corrections. In other words, it is difficult, even in retrospect, to build a model based purely on fundamental factors that can predict 10-20% stock market corrections accurately. I have found that in order to successfully anticipate corrections with a reasonable degree of accuracy, technical analysis must be incorporated.

What is the relationship of stock market corrections and technical factors? I will state the relationship in its most general terms before going on to elaborate later in the article: Pullbacks tend to develop into significant corrections largely as a result of traders and investors being caught "wrong-footed", which sets off a cascading series of selling waves. These selling waves may be largely unrelated and/or uncorrelated to the evolution of underlying fundamentals. The selling waves are fueled by several non-fundamental factors. For example, stop-loss levels are breached, forcing traders to quickly and indiscriminately exit positions. Another factor is related to emotion: Faced with a surprise or being caught off-guard, or perhaps influenced by "herd" mentality, investors and traders may react impulsively. Again, often some sort of fundamental event is the initial catalyst to the waves of selling, but the selling dynamic then takes on a life of its own.

As I have outlined previously, recessions are largely what separate mere stock market corrections from bear markets. Technical dynamics, unrelated to actual fundamental changes, generally only move prices so far and last for so long. How does the current historical juncture measure up on this criteria? Recession is highly unlikely in the next twelve months, according to the best leading business cycle indicators available. However, unanticipated events and/or data that are perceived to increase the risk of recession could trigger an initial round of selling (discounting an increase probability of a recession), which catches a life of its own and devolves into a correction of 10% or more. In such a scenario, if fears of a possible recession are not subsequently confirmed by solid evidence, the stock market decline will likely be limited to something less than 20%, and the losses will most likely be reversed.

Currently, I see several technical developments that, if accompanied by unexpected fundamental developments of sufficient importance, could help catalyze the unfolding of a 10-20% stock market correction.

Short Term

Since early 2015, the S&P 500 has been tracing out a pattern known as an "ascending triangle" - characterized by a flat resistance line near recent highs and an ascending series of higher lows. In an up-trending market, this sort of pattern generally is expected to resolve to the upside. And when it does, it marks a new impulse in the continuation of the ongoing trend.

However, as of this writing (after the close on May 6th), the S&P 500 seems to have broken out of the ascending triangle to the downside. Please note that this break has not yet been "confirmed." However, if it were to become confirmed in the following days, this is an indication that the short-term trend may have changed - or at least become divergent.

(click to enlarge)


Intermediate Term

If you look closely at the above chart you will see a "rounding" pattern since late 2014, whereby successive higher highs have been registered, but at a slower rate of ascent. This suggests a slowing of momentum and a turn in the second derivative.

The downward breakout of the ascending triangle presently places prices on the "wrong side" of the intermediate-term rounding pattern - the side of the rounded shape where a downward trajectory has begun. This could signal that the intermediate-term rounding pattern has exhausted itself on the ascent, and is now ready to turn downward, or "roll over", in technical analysis terms.

Long Term

The blue line in the chart below is a central trend line, while the upper and lower grey lines represent upper and lower channel trend lines. This is a very strong multi-year pattern that has held up well going back as far as 2011-2012.

(click to enlarge)


As can be seen, for several years, the S&P 500 index rarely dipped below the central ascending trend line. However, since mid-to-late 2014, upward momentum has been faltering and the index has not been able to sustain itself consistently above the central trend line. In fact, the S&P 500 has spent most of 2015 below the central trend line - indicating waning momentum, as noted above. More importantly, the S&P 500 is now threatening to break below the lower trend channel. A breaking of the lower channel could be an indication of a trend break and a phase change in the market.

Please note that I don't think that a break of this lower trend channel would indicate a break in the longer-term bull market cycle. However, I do think it would indicate an end to the current phase of the bull market (a phase identified by this trend channel). A trend change and end of a phase may be followed by entry into a corrective and/or consolidation phase. After completion of the corrective/consolidation phase, I believe the next step is likely to be the beginning of a new phase in the longer-term bull market advance.

Technical Analysis Note: Does It Matter?

Stock prices - like all prices - are the product of complex interplays of supply and demand in markets. Therefore, technical analysis, at its best, can be seen as one way to study key economic and financial forces in stock markets - the ones that ultimately determine stock prices. Just as an electrocardiogram can show a doctor how a heart is functioning, price data can tell an economic and/or financial analyst much about the workings of certain markets - and the stock markets are no exception. Technical analysis can be an objective tool used by fundamental analysts to monitor the evolution of fundamental forces.

I do not think of technical analysis in terms of mere geometry; I think of it in terms of the monitoring of economically and financially significant supply and demand patterns that may be reflected in stock price patterns. These supply and demand trends are, by definition, the determinants of price patterns that you see on price graphs (whether you correctly identify the patterns is another story). When you think in terms of price patterns resulting from patterns of economically intelligible patterns of supply and demand, the relationship of identifiable geometric shapes in price data to identifiable economic forces (supply and demand) can help an analyst gain insight.

In the case of the types of technical charts provided in this article, pretty clear price patterns established over several months and years can be seen. By definition, to the extent that such price patterns are not simply a random coincidence, some pattern of supply and demand is probably determining such patterns. For this reason, "breaking out" of established patterns can suggest that there has been a change in the economic and financial forces, or a change in the perceptions of economic and financial forces, that previously determined the patterns. Either way, the break in the price pattern could be suggesting something important is afoot. It's not something absolute; it's not definitive. It is a clue, among many, to be pursued in the long and wide search for alpha.

Conclusion

At its best, technical analysis, or the analysis of price action, only provides clues or hints about the future. Technical patterns must be interpreted with intelligence and care. There is no "one and only" way to interpret price charts. The lines that I have drawn are not the only ones that could have been drawn, nor are these the only technical indicators that could potentially be analyzed. Above all, it is important to keep in mind that insights derived from technical analysis must be thought of in probabilistic terms. Nobody should expect technical patterns to correctly predict the direction of the market all the time. If the signals provided by technical analysis are correct slightly more often than what could be accomplished by chance, they are useful in the pursuit of alpha. This is the spirit with which I offer my technical interpretation.

Simply put: My view is that price action in the stock market is hinting at some possible "changing winds" in the days, weeks and months ahead. If the break of the ascending triangle in the short-term chart is confirmed, and if the market subsequently breaks and confirms a break of the lower channel trend line in the longer-term chart (the break has not happened yet), I think the market may be set up to enter into a corrective phase.

Note that after a break of a strong trend line, snap-backs above the trend lines are not rare. (Indeed, in the graphs provided in this report, one can see several sharp upward reversals after "unconfirmed" breaks of the trend lines.) Therefore, breaks must be "confirmed" before they constitute a true signal. Such confirmations, when they occur, can be swift or can become drawn-out affairs. There are several different ways that a confirmation in the present case could play out. I will keep readers abreast through my newsletter if and when a confirmed break occurs.

http://seekingalpha.com/article/ ... p;uprof=45&dr=1

TigerFox

Be prepared when bears come.

NG_NM

TigerFox 发表于 2015-5-8 05:51 PM
Be prepared when bears come.

谢谢

恒一

cbd

近来熊的呼声越来越多, 大家说MM会怎么办呢, 是要把市场拉高,让这么多看熊的人全踏空然后去追高好被MM宰呢, 还是顺势把梯子一撤, 然后到-20%的地方摆地铺呢? 唉,我要是MM肚子里的蛔虫就好了