Market Analysis

The Rhymes of History

The Rhymes of History are present everywhere if you look closely. As I outlined in Retiring the Bear this week’s drop was no surprise as it was well advertised in the charts and sentiment. As promised I wanted to share some structural charts that may put the drop in a historical context.

There’s a lot of talk of who and what to blame for the drop. Searching for explanations is common practice following a big drop and i’ll leave that to others, but my view is simply that it was technically based.

We were massively extended and a reconnect had to happen and did happen. In the same token the bounce off of the lows so far is also not a surprise as we had reached massive oversold readings on $NYMO as I outlined on Monday:

Markets are obeying technicals nicely and allows us to navigate through the now much more volatile action. And that’s a good thing. I don’t know about you but 2-3 handle intra-day ranges are not my cup of tea. I prefer wider trading ranges. So recognize markets have changed and one must keep an eye on the tea leaves.

So let’s look at the big structures for historical cues.

Firstly here’s what happened, a big uninterrupted ramp up followed by a big snap lower into key MAs:

In  many ways this move is completely consistent with previous major topping processes. A massive ramp higher, a quick rug pull of over 10% (12% as a matter of fact) producing an oversold RSI reading and now a bounce.

And the timing of the snap rhymes with previous examples.

Recently I’ve mentioned the global Dow Jones, the $DJW, as the monthly RSI reached virtually the same overbought reading as in 2007 when it snapped lower and produced a fast correction:

What’s notable here in particular is that this snap occurred at virtually the same time then as it did now, in February following a lengthy virtually uncorrected move higher.

Here’s the $SPX back then:

The current action is then eerily similar in time and in context. Back then the initial rout produced an oversold RSI reading for the first time in a long time. That low was followed by a bounce into the middle RSI, then a new low on a positive divergence followed by a larger rally.

Back then we went on to make 2 more new highs with intermittent 2 way action:

This is a scenario that could be considered to be a possibility here as it leaves room for the upside risk targets discussed in the 2018 Market Outlook. This way everyone would get bullish again, the correction would be viewed as another blip although back then it already marked the beginning of the end.

Note the initial drop in February, despite more highs following, resulted in much more volatile price action for the entire year before falling apart:

Bottom line: The 2007 top was a process that took months to unfold providing ample of 2 way price action opportunity.

A couple of weeks ago before the big drop in Weekend Charts I showed the ADX directional indicator being as extreme as in 2008. I note that this year’s reversal has come at precisely at the same historic extreme as in 2008:

Back then we saw new lows emerge in the months ahead on a negative divergence. The mirror image here would be new highs on a negative divergence, supporting a potential replay of the 2007 scenario.

The flip side here is if markets cannot make new highs. We’ve seen this play in 2000 following the market peak in March:

The initial low followed a fast 14% correction and the subsequent back and forth produced a lower high which then marked the end of the bull:

The bottom line here: As extreme as markets have been, on a structural basis they are obeying the very signals they have respected in the past. The volatility game has changed, gone are the days of 2-3 handle intra-day ranges and technicals are dominating. This provides traders with a lot of 2 way action opportunities, but also puts participants on notice: This week was a major warning and while new highs may still come they are by no means a guarantee. Participants may be well served paying close attention to the emerging rhymes of history.

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