From Calm Seas to Maelstrom in 60 Seconds
Wow! What a week already. Two weeks ago the market was a sea of tranquility. We were on pace to break the all-time record for longest streak without a 5% decline, were already setting records for consecutive days without a 3% drop and it was whisper quiet with the VIX index at 11.08. Then BOOM, the market dropped 8.2%, the VIX surged to 37.32 by Monday and I am still dizzy from all the gyrations that took place today - a 306 point Dow drop before eventually going up 567 or 2.33%. A sudden increase in turbulence always brings up the question: is this the beginning of a bear market?
Well, a bear market is coming and what a bear! It has the potential to dwarf the Financial Crisis in both magnitude and length. I will discuss more about the causes in future blogs and articles. You might even want to check out my introductory web article on the subject - It's Not Over!. At this time, however, it may be more important to address the question: are we there yet?
To get started, let me explain some of the charts you will see in this site. As a student of the markets for over two decades, I have seen plenty of market bumps and dead cat bounces and I have developed some tools to help me keep my blood pressure down, One of these is the Crest chart. Two of these are shown on the webpage. Basically, they help verify market tops. To illustrate, consider the Crest charts for the last four major market downturns - 1987, 1998, 2000, and 2007 - shown below.
All of the charts have quiet areas I call noise and peaks I dub “crests”. The noise is the base line – an uptrend with steady increases in the market. Crests occur when there is an inflection point to the uptrend, that is, when a market tops and the trend shifts to a downturn. These crests can be sharp and very intense or jagged, consisting of a number of peaks. When a market goes up, comes straight down and recovers you get a sharp peak. Such was the case in October 1987 and to a lesser extent in October 1997. The more violent the climax and subsequent crash, the more intense the crest peak. Bear markets of short duration typically result in sharp Crest charts. Short corrections, like the one in 1997, can do the same.
That is not the case with protracted and severe bear markets. These are slugfests where bears and bulls duke it out well before the market tops. The result is a jagged crest range that mirrors the market’s rollercoaster ride. This is what happened in 1998, 2000 and 2007.
It sure would be great if Crest chart tops corresponded to market tops but the math behind the charts does not work that way. Usually, the market tops in the initial stages of the crest. You probably groaned just as loudly upon reading that as I did when I started working with them. The
chart’s usefulness is not so much in timing the market as in verifying that a bear market has indeed begun, rather than having to wait until a significant drop declares it as a major correction or bear market. There is no substitute for rationally analyzing fundamentals and making portfolio preparations accordingly and that is why I set up this website initially - to get people prepared even before the recent drop.
That notwithstanding, let’s look at today’s market. This weekend, I warned readers to keep watch in the coming weeks since the Crest chart had crept to the top of the noise level, see white arrow in the chart below. If the chart kept rising to the level of previous bear markets, it would indicate a serious move was on. As you can see from the chart, the last two market days have created a huge surge, at a level (1.6 E10) consistent with previous bear market moves. This could still be just a short correction much like in 1997. However, if the chart goes down and then comes right back up it would indicate that a complex, jagged crest pattern is developing and a major move to the downside is in the works. Should that move materialize, it will make Monday’s 8.2% market decline seem heavenly by comparison. Given the potential for that, a prudent investor would prepare rather than hope this is just a minor bump.