The best thing one can do when it is raining, is to let it rain.
-- Henry Wadsworth Longfellow
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In last week's article, I discussed the ~88% correlation of the Fed's balance sheet to the S&P 500 Index (^INX) since the 2009 market bottom. I opined that if the Fed stops pumping cash into the system – what's now being referred to as tapering – the probability is that there will be a correction in the general stock market. Continuing this thought, today I will comment on the recent volatility and expansive moves within the period.
The period under discussion stems back to the 2009 bottom and transition from a cyclical (one- to four-year) bear market to a cyclical bull (illustrated in the previous chart). What's also evident are the three distinctive trends since this transition occurred (A, B and C). 'A' is considered the cyclical bull trend; 'B' and 'C' are the secondary and tertiary trends within. What's worthy of attention is how, in a bull market, the trends will continually expand at a greater rate until they are finally exhausted.
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The October 2011 bottom (post-Greek debacle) changed the trend from A to B as the market began to expand at a greater rate due to broadening investor confidence and further quantitative easing. In the same vein, the November 2012 low (amidst the fiscal cliff debacle) again shifted the trend from B to C and once more, increased its slope (return average per month). Since this last transition the market is up 21.5% in nearly seven months.
When examining the market closer (daily chart), it becomes apparent that a quaternary period has appeared (trend 'D'), originating from the mid-April sell-off. Albeit distinct, the market has already broken this and has come to re-establish support back on its prevailing C trend, right at its 50-DMA (day moving average). This analysis is, in its simplest form, very powerful information when considering the end of market cycles begin with the non-continuation of trend expansion. Otherwise stated, if the trends do not continue to expand and break down to their previous trends, it is a signal that a consolidation period may be lurking around the corner.
As every investor is aware, the S&P 500 has multiple declines per year to the tune of 5-10%. These short-term corrections can lend opportunity to an otherwise volatile market. However, if the rain continues to pour and there is no further expansion once a consolidation period has concluded, it will more than likely lead to a much greater loss to the tune of 20%-plus.
The typical term used for the quaternary D expansion is a "buying climax." These are contrarian warning signs of everyone being on the same side of the fence – all buyers and no sellers. Now that it has concluded, investors should watch for further expansion or a break of trend C. As we enter the summer "slowdown" months, it is important to be alert. If trend C breaks, trend B is near the 200-DMA (~1,500), another 10% decline from current levels.
I hope this helps and finds you well
Editor's Note: Read more at Tesseract Asset Management.
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- Henry Wadsworth Longfellow