The long-expected correction finally arrived. It became official when the S&P 500 dipped below 2585 last Thursday. Is this just a steppingstone to the next bear market or is the last two day’s move up an indication that the market is mending its ways and the correction is on recovery mode?
To answer that question, I developed Dive charts. I use them to figure out when markets bottom and they are better at doing so than Crest charts are with market tops. One can usually get within a couple of days of the bottom if not the bottom itself. If you are curious to find out how they are built, I go through all the details in my upcoming book, And Then the Tempest – The Imminent Financial Meltdown is Real and What to do About It.
For now, let’s find out how they can be used to figure out if we are on the way up from a market bottom or if there is more pain to come. There are two sets of data points. One is based on open/close data and the other on daily highs and lows. If you look at the current chart, shown below, you will find there was a quiet period with very little movement through the better part of 2017. That is not surprising considering this past year was one of the least volatile
in history. I call this quiet period the noise or baseline. Note that there is a horizontal line marking the bottom of the noise. I refer to this as the lower channel. Basically, anytime the Dive chart goes below the lower channel, that indicates the start of a downturn.
The lower channel was breached January 24, two days before the market top Friday, January 26. Usually dives will bottom out a little over 10 percent from the high on the day the lower channel is breached. A ten percent drop from that day’s intraday high of 2852.97 is 2567. We reached that level last Friday on the way to the intraday low of 2532.69. That would be the end of the story if this was a simple dive pattern. Unfortunately, it may not be that simple.
Even sharp bear market drops like the one in October 1987 have more than one dive, as shown by the Dive chart for that year. Readers of previous posts would be aware that my expectations are for a bear market to begin sometime this year. It will be protracted and of magnitude. Historically, such severe bear markets have complex Dive patterns where one dive is followed by another. The Dive chart for 2008-2008 is a case in point.
When a dive does not recover completely but falls short of going back to the lower channel before diving again, that is called a dive-on-dive pattern. This is a signal that a complex dive pattern is in the works, the market bottom has not been reached, and that more pain is ahead. The second dive need not go down 10 percent before recovering slightly and diving again. This is what happened repeatedly in 2008 and 2009 as bears and bulls wrestled for control of the market.
Despite last Friday’s gains, the market continued on dive mode. That changed today as shown by the chart’s sharp turnaround. Should the market continue to rally and the chart continue rising to reach the lower channel, then we will be in the clear, indicating a simple correction and rally. However, if the chart dives again, beware. This means we are not out of the woods and may be in the beginning stages of the long slog through the predicted mega bear market. Keep posted to find out which.