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Ugly Day

sp500-annotated-2014-02-03
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Lot’s of really ugly bon mots about the sell-off today:

· worst February start since 1982 for the Dow
· worst monthly start since 1972 for the NASDAQ
· S&P closed the furthest below its 100-day in over a year
· worst February start of the entire market since 1933

I thought that given all of the news about the market and the > 2% drop today, we ought to take a look at the graph and see what it is saying.

I’ve annotated the graph above with some red circles – these circles show you what investor sentiment is saying. Both of these show readings below their lower indicators and say that we are due for a bounce higher.

I’ve also put some green arrows on the graph showing how the market, during all of 2013, would bounce higher off the 100-day moving average (the green dashed line), but today we broke decisively below it.

I also added two purple boxes to show you the last time that the market was trading below the 200-day moving average (the bold green line). It has been well over a year since we last traded below the 200-day MA.

All of this says to me that we will likely get an oversold bounce higher tomorrow or the next day, but I think we are due for a trip to the 200-day moving average.

But the real question is: are we going to see a change in the trend from a bullish up-tend to a bearish down-trend? Let’s look at my Trend Change chart below:

trend-change

We have looked at this graph in the past here on the blog, but not in a long time. The essence of the graph is the relationship of the S&P 500 Index monthly price graph compared to its 10-month moving average with the 7-month Relative Strength Index used as a timing key.

What I like to look for as a change in the market’s character is a situation where the RSI has been either above or below the top and bottom indicators, then change direction – this reflects an extreme change in investor sentiment. And, we then look for a move of the index to cross over the 10-month moving average.

I have circled several instances on the Trend Change graph showing you how a change in trend can be a significant event for the index. Right now, the S&P 500 is at 1,741, falling today by about 40 points. However the 10-month moving average is at 1717, or about 24 points below today’s close. You can also see that the RSI has fallen below the top indicator line and is heading lower.

Is it time to panic? No – the big change in trend that took the market down to crash levels happened due to major financial crises. Do we have one of those ahead?

Check out the Kansas City Federal Reserve Financial Stress Index:

kcfsi_max_630_378

We’ve reviewed this index published by the Fed and you can see that it is not flashing a warning sign that we have some systemic issue that would cause a crash.

Let’s take a look at the Fed’s National Financial Conditions Index that also measures risk:

nfci_max_630_378

Again, this index is not showing any sort of systemic issue that would cause a market crash.

Another worry that can cause a market crash (or at least a > 20% correction) is a Recession. Let’s look at the Recession Probabilities Index:

recprousm156n_max_630_378

There is nothing about this index that says we are nearing a recession.

Given that the three primary indices I follow to give me a feel for whether we are nearing a correction of crash proportions are stating all is quiet, my conclusion is that the current correction is a normal pullback to or a bit below the 200-day moving average.

For people who are under-invested, this can be a real gift as it gives them a chance to get into the market. For everyone else, the key is to hang-on, don’t do something stupid, and ride out the dip. The biggest concern I have is whether we will move back higher once we bottom or will we move sideways to allow the various measures of valuation we follow to catch up with prices.

One way or another, prices and valuation realign – it just depends on how you take your medicine – fast and painful drop in prices or a slow grind sideways while earnings grow and P/E’s fall – different strokes for different folks.

However, it might not be the time for a realignment and we could simply have a repeat of the two moves below the 200-day moving average in the purple boxes on the graph at the top. We will only know by watching the indicators and seeing what they tell us – and as always, we will keep you informed here on the blog.

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Thanks for reading!


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Mark

Keep an eye on the blog as we will keep an eye on the trend change chart