Short Takes is a stock market blog updated regularly by Ciovacco Capital Management, LLC. This financial blog covers investing topics, such as economic cycles, stocks, commodities, currencies, and technical analysis.
An April 5 video covered a rare momentum shift in the S&P 500 that went into the history books on March 29 (see point A below). The study was updated in this week’s video, which can be found below in this post. The second leg of the study was conducted after the 12th consecutive weekly close above the S&P 500’s weekly MACD centerline (see point B below).
Given the market has pulled back since April 5, does the magnitude of the pullback between point A and point B raise concerns relative to market pullbacks that took place over a similar seven-week period in the sixteen historical cases? The answer is no. The table below shows the median drawdown that took place between similar points in the historical cases was 3.35%; the maximum drawdown was 7.06%, with 81% of the sixteen cases seeing a drawdown of less than 5%. The S&P 500’s 2019 drawdown comes in at a similar level of 4.55%.
Thus, to date, the market has not done anything to seriously jeopardize the original finding of keeping an open mind about better than expected outcomes in the stock market over the next 2-3 years. More details about the studies and the market’s subsequent historical performance can be found in the video below. Our schedule required this week's video to be recorded offsite.... if audio seems a bit off, should be back to normal next week.
Stock Bears To Finally Have Their Day In The Sun? - YouTube
SPEAKS TO ODDS
Each year is unique and 2019 will follow its own path. The 2019 setup and the market’s performance in the sixteen historical cases help us assess the probability of good things happening over the next few years relative to the probability of bad things happening. The U.S./China trade situation remains fluid, reminding us to maintain a flexible, unbiased, and open mind about shifts in the headlines and data.
The dramatic turn in the trade negotiations that has taken place since the stock market closed on Friday, May 3 is captured in the segment below from The Wall Street Journal:
“The U.S. and Chinese governments both sent signals ahead of their trade talks in Washington last week that a pact was so near they would discuss the logistics of a signing ceremony. In a matter of days, the dynamic shifted so markedly that the Chinese deliberated whether to even show up after President Trump ordered a last-minute increase in tariffs on Chinese imports because the U.S. viewed China as reneging on previous commitments.”
The markets are adjusting to the shift from a cooperative phase in the trade war to an escalation phase. The drop in the U.S. stock market futures on the morning of May 13 after China announced another set of tariffs on U.S. goods sends a clear message the financial markets are concerned about the economic damage that could come from an ongoing and combative trade war. The million-dollar question is how long will the current escalation phase last? Markets will have higher odds of stabilizing if the U.S. and China can show some signs of possibly making their way back to the negotiation table.
There has been a slight shift in the data associated with the market’s long-term trend, but nothing earth-shattering at this point. Today’s relatively small adjustment to our asset mix got us back in line with the data and respects the uncertainty related to the duration of the current decline.
The market’s waning momentum in recent weeks told us to be open to a normal 4-10% pullback in the S&P 500. As of Monday’s close, the S&P 500 has experienced a drawdown of 4.55% based on closing prices and 5.17% using the recent intraday high and intraday low.
FIRST 90% DOWN DAY
Monday brought the first day in 2019 that featured extremely lopsided volume figures. Over 90% of NYSE volume was associated with declining issues.
We know a 5% correction falls into the normal and to be expected category. How concerning is a 90% down day? As shown in the table below from Pension Partners, forward returns and percent positive figures for the S&P 500 are slightly better following a 90% down day relative to an average day.
The chart below provides a good visual proxy for the, thus far, relatively small shift in the data related to the market’s longer-term trend. The S&P 500 closed below the 50-day and below the gap. Price still remains above a still upward-sloping 200-day.
The VIX was a mixed bag during Monday’s session. It printed a daily closing high above last week’s high, but the intraday spike was lower than last week’s spike. Since closing prices tend to be more relevant, it is probably fair to say the VIX closed Monday in “still concerned” mode.
As noted in this video clip, even under a favorable longer-term outcome scenario, the market may continue to be volatile over the next 90 days. It is possible we will sit tight for the remainder of the week; it is possible the data will call for additional incremental steps to reduce exposure to risk assets. We will continue to take it day by day with an open mind about all outcomes.
A little after noon Eastern time on Sunday, President Trump shifted the odds related to this week’s scheduled trade talks between the United States and China.
LONGER-TERM OUTLOOK REMAINS FAVORABLE
Given the look of the chart below during Monday’s session, it is fair to say the market’s longer-term trend remains favorable, something that is reflected in our current mix of stocks, bonds, and cash.
SHORT-TERM EVIDENCE OF WANING MOMENTUM
The market has moved a long way since making a V-bottom late in 2018 and is starting to show some signs of slowing momentum on shorter-term timeframes.
Under our approach, the million dollar question is:
Are we allocated properly based on the evidence in hand?
After making one minor chess move to lock in some gains in SCHB during Monday’s session, the answer is yes. Our exposure to cash and bonds takes into account the increasing odds of a 4%-10% pullback. Our exposure to stocks takes into account the term “odds” in the previous sentence and reflects the still favorable long-term outlook.
It is possible the waning momentum above will be followed by a pullback. It is also possible the market is simply pausing to digest the previous gains before pushing higher. In any event, the market’s intermediate-term risk-reward profile is not as favorable as it was a few weeks ago.
FIRST SET OF GUIDEPOSTS
Given present day facts, we will most likely be able to sit tight should the market decide to revisit the gap and or 50-day moving average shown in the chart below. Hypothetically, a move back toward the gap could represent an opportunity to redeploy some of our cash. As always, we will see how things unfold on the data front over the coming days and weeks. We are simply outlining one of many possible outcomes. As long as the USA/China trade meetings remain on the docket, it is easier to sit tight and respect the still-favorable long-term outlook. A cancellation of the trade talks could bring stronger selling pressure and lead to a decline of greater duration and magnitude.
SCHB has been lagging SCHX in recent months, which made it easier to lock down some of the gains in SCHB. Our last buy in SCHB came back on 2/22/2019.
On a positive note, the S&P 500 is still making a series of higher highs and higher lows. Protecting gains while trying to stay with the existing trend is a balancing act based on hard data and probabilities.
If selling conviction picks up later this week, another area of possible support lies between 2722 and 2815. A drop back to 2722 would represent a 7.5% correction from the recent closing peak of 2945. As we all know, a 7.5% pullback falls into the “normal and to be expected from time to time” category.
CONFIDENCE vs. CONCERN
The most relevant question is not “what was your last trade, a buy or a sell?”, but rather “how are we currently allocated between stocks, bonds, and cash?”. It may be helpful for clients to review their household allocations in these terms, which reflects all the data we have in hand (model/trends/bird strike):
% Allocation to Stocks = % Confident
% Allocation to Cash + % Allocation to Bonds = % Concerned
Given what we know today, it is prudent to be confident, but some concern is also warranted in the short-to-intermediate term. If the facts evolve in a manner that justifies some additional adjustments in the coming days/weeks, we will not hesitate to act.
This week’s video covers four long-term “be open to better than expected outcomes” setups in the financial markets.
RAPID REVERSAL HAS ONLY OCCURRED THREE OTHER TIMES SINCE 1987
A rare shift recently took place in the NYSE Bullish Percent Index. According to stockcharts.com:
The Bullish Percent Index, or BPI, is a breadth indicator that shows the percentage of stocks on Point & Figure Buy Signals. There is no ambiguity on P&F charts because a stock is either on a P&F Buy Signal or P&F Sell Signal. The Bullish Percent Index fluctuates between 0% and 100%. In its most basic form, the Bullish Percent Index favors the bulls when above 50% and the bears when below 50%.
In late December 2018, the NYSE Bullish Percent Index reached an extremely low reading of 19.16. As shown in the chart below, that level has only been reached in four other periods: 1987, 1998, 2008-09, and 2011. In the 2018-2019 case, it took only 65 calendar days for the NYSE Bullish Percent Index to climb to 61.96.
The only other shifts that occurred in under 100 calendar days took place in 2008, 2009, and 2011. In the chart below, the 2008 case is denoted by 1A and 1B, the 2009 case by 2A and 2B, and the 2011 case by 3A and 3B.
WHAT HAPPENED NEXT?
The first table shows S&P 500 performance for all three cases after points 1B, 2B, and 3B. The second table shows S&P 500 performance for 2 of the 3 cases. The message from both tables is while givebacks and volatility could be part of the equation over the next 60-180 days, historically, in all three cases, S&P 500 performance was extremely satisfying over the next six years. Since we know 2019-2025 will follow a unique path, the historical cases simply help use assess probabilities in the days, weeks, months, and years ahead.
COMPARING ALL CASES TO 2019
Given the S&P 500 was 26.3% lower 60-days after the NYSE Bullish Percent Index climbed back to 61.96, it is probably fair to say 1/5/2009 is the most concerning historical case. How does the market’s profile on 1/5/2009 compare to the profile on 3/1/2019? The chart below shows the S&P 500’s 50, 75, 100, 125, 150, and 200 day moving averages on 1/5/2009.
The chart below shows the same moving averages on 3/1/2019, the day the NYSE Bullish Percent Index hit 61.96. The market’s profile was much stronger in the 2019 case relative to the 1/5/2009 case, meaning the odds of a another leg down were quite a bit higher on 1/5/2009.
How does the 3/1/2019 case compare to the 4/16/2009 case? As shown via the charts below, the market’s long-term profile on 4/16/2009 was quite a bit weaker than the profile on 3/1/2019.
How does 2019 compare to the 10/27/2011 case? Once again, the market’s 2019 profile was stronger on the day the NYSE Bullish Percent Index climbed back to 61.96 relative to the same milestone date in 2011. The strength of the market’s profile speaks to the odds of a significant (10% plus) pullback in the stock market.
WHAT TRANSPIRED IN ALL CASES?
Since the NYSE Composite Index contains approximately 1900 stocks, a shift in the NYSE Bullish Percent Index from below 20 to above 60 means the shift in bullish conviction was strong enough and broad-based enough to push approximately 760 stocks from P&F sell signals to P&F buy signals. It is very difficult for a shift of this magnitude to occur without the backing of large institutions. In all the historical cases, when a similar institutional shift took place in the market, stocks were higher six years later by an average of 121%. A similar shift took place between December 2018 and March 1, 2019, telling us to keep an open mind about much better than expected long-term outcomes in the stock market. Historical performance in the first 180 days also reminds us to have realistic expectations about red days, red weeks, and red months.
THE WEIGHT OF THE EVIDENCE
Data is only available for the NYSE Bullish Percent Index dating back to 1987, which means any rare event will be based on a small sample size. However, this week’s video provides additional evidence from other sources dating back to 1950 that paints a similar be open to better than expected long-term outcomes picture.
Are Stocks Closer To A Major Top Or A Major Bottom? - YouTube
DAY BY DAY
Charts cannot predict the future; they simply help us assess patterns in human behavior from a probability perspective. The data we have in hand as of April 30, 2019 aligns with the possibility of better than expected outcomes. As long as that is the case, we will allocate accordingly. If present day data shifts in a meaningful way, we will reassess the odds and make adjustments to our asset mix if needed.
This week’s video outlined some signs of slowing short-term momentum in the S&P 500. Given the duration and magnitude of the current rally, concerns still remain. However, Tuesday’s session did provide some notable short-term shifts on the S&P 500’s daily chart.
The comments via the video clip/link above regarding the same indicators on the S&P 500’s weekly chart still apply. The market has provided numerous forms of “be open to higher highs” evidence over the past 90 days; some examples can be found here. We will continue to take it day by day, keeping an open mind about all outcomes, especially over the next three to six weeks.