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Markets – Macro – Stocks – Charts – Alerts

The Case for a basic 11% Correction

MarkTwainWbMark Twain was a funny fella. He is one of these iconic people in history I would love to be able to meet. There are so many great quotes of his around. Pertaining to our trading world here are several classic ones:

OCTOBER: This is one of the peculiarly dangerous months to speculate in stocks in. The other are July, January, September, April, November, May, March, June, December, August, and February.

There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.

“History doesn’t repeat itself, but it does rhyme.” – Mark Twain

Brilliant stuff. He is right of course, especially about the last quote. History does not repeat exactly, but it does rhyme. Central banks are also keen on not wanting to see history repeat itself and they have put forth a valiant effort. But they can’t change the laws of gravity. How do I know so? Because people who can’t get a single GDP forecast right can’t change the laws of gravity.

And what does the law of gravity suggest when it comes to the stock market? Regression to the mean, specifically the middle monthly Bollinger band. This is what has always happened and will happen again. This does not mean a crash, but a quick glance at a long term $WLSH chart makes the case abundantly clear:

$WLSH

QE3 disconnected the market for a record amount of time & distance from the middle monthly Bollinger band. This run has been incredibly bullish, but it is as disconnected as it has ever been. Time wise the nearest comparison is the 1995-2000 bull run.

Even during this run we had 2 dips toward the middle Bollinger band. And hence calling for such a corrective move is not calling for an end to this bull market. It is simply saying that such a correction would be perfectly consistent with the market’s history. A reconnect from current levels implies a 11% correction and as the 1998 and 1999 examples show: Reconnects can happen very quickly.

Now note that the monthly MACD has yet to cross over, but all the other elements are in place and, as we discussed this weekend, internals certainly augment the case.

Will Janet Yellen ever permit such a move? Or can she even afford to let it happen? Or will she powerless to prevent it? Well the last two times the $WLSH touched its middle Bollinger band was when the previous QE efforts ended. The Fed folks didn’t like either instance very much and promptly launched more QE. Another round of QE is scheduled to end in October. October has some wild stock market history behind it. Maybe it won’t repeat, but it may rhyme.

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