A look at the Crest chart for last Friday, March 9, reveals, not surprisingly, that the crest is over. The chart is back to its baseline, indicating the market is in a build-up phase. By contrast, it’s counterpart, the Dive chart, provides a different message. While it does show that the dive is mostly over, it has yet to recover its lower channel, indicating that there may be more downside movement in store.
S&P 500 Crest Chart 3/9/2018
S&P 500 Dive Chart 3/9/2018
As my previous blog, Not Out of the Woods, summarized, a study of major bear markets indicated all of them gave advance warning a month to 5.4 months prior to their big drop. This came in the form of a sizable drop. When that initial drop was a correction, five out of six times the market topped within 2.9 to 5.4 months.
As I have written previously, demographic forces will cause a sizable decrease in consumer discretionary spending, which will precipitate an economic downturn. Profits will shrivel as a result of the downturn. From these lofty valuation, the level of disappointment that will descend upon Wall Street will be of such magnitude and proportion that a mega bear market is inevitable. If this market follows form to all other major bear markets, then we should be seeing a market top come no earlier than 2.9 months after the initial peak January 26. That would place it around April 20.
Yet, last Friday’s high of 2786.57 is only 3.0% away from the January 26 peak. That is only 0.4% away from the topping range found in my study. Is it possible we are going to reach the drop off point early this time? A look back at the previous six major bear markets that went through a correction before toping, showed that all but one dove steadily to the bottom of their correction period and then recovered sharply. The only notable exception was the 2000 market whose S&P 500 performance during that span is compared to ours in the chart below. The left-hand scale belongs to the orange 2000 market, while the right-hand scale belongs to today’s market in blue.
Note that both markets dove sharply not long after their initial peak only to recover quickly and then become very volatile, rising and dropping repeatedly. The 2000 market repeatedly knocked at the -3 to -4% range of the initial peak for close to two months before finally breaching that level. It continued to vacillate at that high level until 5.2 months later, finally peaking September 1 just 1.5% points shy of the initial high.
Therefore, it is possible that this market may follow suit and continue flirting with the -3% level for quite some time before finally surging above it en route to its climax.
A Crest and Dive chart analysis of the 2000 market might provide insight as to what’s in store for us in this bear market rendition.
As proved to be the case for our market, the 2000 Crest chart showed that, within weeks of the crest, the market had regained its baseline and was in build-up mode. This was a far more complex Crest chart than ours. Unlike ours, the 2000 Crest chart was more timely giving advance warning of a market top with an initial peak March 16. The market topped six trading later, before crest peaks April 4 and April 14, the latter being the major one. This is consistent with a warning I gave on my blog, From Calm Seas to Maelstrom in 60 Seconds - major crest peaks usually provide a late signal for market tops. Sometimes Dive charts provide an earlier warning, as was the case in our present market.
This came on March 15 on the Dive chart. The market had just recovered its lower channel when it breached it again March 15, indicating a drop was coming. These were volatile days and, as discussed in my book, this was reflected in the complexity of the Dive chart. The market would regain its lower channel May 4 only to dive again during an 8.1% drop. It would regain its lower channel a month later on June 7 and continue on a build-up phase to its zenith September 1st.
What can one take home from this? First, I will admit these charts are complex, but that is only because they reflect volatile market behavior. That in itself is a benefit since it allows for tradeable moments. Second, don’t jump the gun just because the dive looks to be just about over. Unless the chart regains its lower channel, there is every chance that it will dive right back again. This is an important point in today’s Dive chart since it has yet to regain its lower channel. Even if it does, it may only do so briefly, as happened in the 2000 market. Finally, our recent jump in volatility may well mean that this market will behave similarly. Nevertheless, note that both the Crest and Dive 2000 charts had quiet build-up periods. That has yet to happen in our market so I expect that to be a precursor to the final top.
Aware that both charts may give you a late signal, it behooves you to take the lessons from the Not Out of the Woods study to heart. If this week brings with it more gains, this market may be going off the historical script. In which case, it could continue even higher than the historical top from 1946 at 2.9% above the previous high. Nevertheless, you might want to play it safe and consider the traditional exit point of 2.6 to 1.5% below the previous high.