Having a reasonably accurate expectation of the direction of the market in the near and intermediate-term can provide investor confidence, peace of mind, and enormous advantage over the millions of other investors with whom he/she competes with every trade.
Based on some key indicators, we called the recent selloff only a day before it began in our February 20 article, "Too Far, Too Fast (2020)." Let's take a look at what's likely next, based on some of those same indicators...
Which way from here?
Which direction will the market go in the near term? For our purposes, "the Market" is represented by the S&P 500 index, which consists of 500 of America's largest publicly traded corporations. This index is the most popular and respected composite of 500 of America's premier companies by both professionals and amateur investors alike.
First off, we will start by establishing the fact that the S&P 500 is in a Bear Market mode. A bear market is conventionally defined as a drop of -20% or more from a previous high, which the S&P 500 established in the last month as it plummeted from a daily closing high of 3386.15 on February 19 to a daily closing low of 2237.40 on March 23.
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"The S&P 500 lost -33.92% of its value – establishing this selloff as the fiercest and most rapid crash in stock market history – erasing some $20 trillion in wealth in 22 days." |
In 22 trading days, the S&P 500 lost -33.92% of its value – establishing this selloff as the fiercest and most rapid decline in stock-market history. If we use the intraday highs and lows, the amount lost is even more significant at -35.41%. Regardless of how it's measured, some $20 trillion in wealth got wiped out in 22 days.
Bear Market Blues
A more rational way investors can confirm that stocks are in a bear market, one that makes more sense than the arbitrary 'down -20% from a high' definition, is to identify when prices have broken below an established, secular, Long-Term Support Line that defines a Bull Market.
Every bull market since stock prices began demonstrates these secular support lines. The Support Lines can have different angles of trajectory, depending on the growth story of that era, but these Support Lines but these Support Lines don't get pierced in a significant way until a Bear Market begins. There may be an occasional day or week in which the Support Lines are broken, but the recovery back above to 'correct the error' is usually quite rapid.
When a Long-Term Support Line established during a secular bull market is definitively broken, it becomes abundantly clear in the charts.
Chart 1 below shows the last three bull markets with green Long-Term Support Lines marking the lows of those upward rallies, and a red circle identifying the moment when the market breaks down to form a Bearish decline. On the far right, we can see that the S&P 500 has definitively broken below its green Long-Term Support Line that was first established
back in 2008.
Chart 1: Bear Markets are accurately identified by significant downward breaks below rising, secular, Long-Term Support Lines (dotted green).
Stocks are Testing the 38.2% Fibonacci Retracement Zone
Fibonacci patterns are useful in determining possible retracement levels after a selloff. Only in rare situations do these levels not hold the key to where prices will stop climbing.
Chart 2 below shows that S&P 500 prices initially bounced sharply higher (17.2% gain) towards the 38.2% Fibonacci Retracement level, then fell rapidly by -6% before bouncing again on Monday by 7% to close the day just below the 38.2% Fibonacci level. On Tuesday, bulls attempted to push prices higher above the 38.2% level but ended the day being driven back to where they started just below that critical level. (Always remember that it is closing prices – and even better, weekly closing prices – that count.)
Chart 2: After the initial -34% selloff, shares bounced sharply higher by 17% to just below the 38.2% Fibonacci level. They have stayed in this zone ever since.
This doesn't mean that prices won't surge higher to the 50% retracement level, but the probability is growing that – informed by additional bearish indicators – in the coming days and weeks, we will see prices return downward to test the March 23 low at 2237.68.
It would be unimaginable for prices to form a V-shaped bottom and return to the levels of prior highs, particularly in light of the fact that unemployment is expected to shoot from 3.5% to 10% or higher in just a couple of months, and business bankruptcies will be off the charts. The economy has entered a recession that simultaneously spans the globe, and it would be unimaginable for the market to resume prior highs in the face of such economic devastation.
Once a retest of the market lows occurs, we'll need to make another assessment to determine whether a full recovery is possible or if we are just at the beginning of a long bear market that could see the S&P 500 decline to the 1500-1600 level (-42% lower), which established the top of the prior two market cycles.
The uncertainty surrounding the COVID-19 virus makes forecasting virtually impossible. Investors have no idea whether the current lockdown situation is going to last for a few months or six months or a year. Moreover, there's a possibility that while the virus may decline in the summer, the fall and winter months could bring another resurgence of the disease.
It is for this reason and many others that ETFOptimize has long relied on 'nowcasting' as opposed to forecasting. Nowcasting involves a strategy responding to current conditions – rather than attempting to anticipate future conditions based on current conditions. The wild ride that investors have seen occur in the last couple of months proves that the future can never truly be anticipated with accuracy.
Just as 12 years ago very few were anticipating collapsing real estate prices and the global financial lockup that resulted, no one today could have anticipated that a pandemic would span the globe and wreak so much economic havoc in such a short amount of time.
We plan to publish an article in the future that draws the distinctions between forecasting vs. nowcasting.
Indicators are Pointing Towards a Retest of March 23 Lows
You may be asking, 'What are these other bearish indicators?" Glad you asked...
Elevated VIX
Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market's expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors' sentiments. It is also known by other names like "Fear Gauge" or "Fear Index." Investors, research analysts, and portfolio managers look to VIX values as a way to measure market risk, fear, and stress before they take investment decisions. – Investopedia.com
Chart 3 below shows that the CBOE Volatility Index ($VIX) remains extremely elevated and is holding at a very high level of 46.70. For perspective, the current five-year average for the VIX is just 16.8.
Smart-money investors are using the VIX to hedge for further downside – and doing so in a significant way.
Chart 3: This chart shows that after averaging in the teens for the preceding months, VIX shot up to 80+, then began to decline, but remains elevated at 46.70.
Chart 4 below provides perspective on the chart above by displaying a 35-year history of the S&P 500 index (top pane) and the Volatility Index ($VIX) in the bottom window. You can see from this long-term chart, which begins a few years before the start of the Volatility Index in 1990, that elevated levels above 40 (red line in lower window) are quite rare.
There have only been three prior incidents in which the VIX rose above the 40 level for a significant period – in the 1998 Russian/Asian currency collapse, the '08-'09 Financial Crisis, and briefly in late 2011 when Republicans shut down the government (resulting in a downgrade of government bonds) at the same time that a collapse of the Euro economy seemed entirely plausible. Today's VIX level is higher than all but the Financial Crises highs.
For perspective, the green line in the lower window shows the five-year average of VIX prices, which has remained below 20 since 2014 and currently averages 16.8. The current level of the VIX is higher than all but one time in history – which occurred during the 18-months long, -56% decline in the Global Financial Crisis.
For some, this financial nightmare may just be getting underway... But for savvy investors using a quantitative ETF strategy, it presents an incredible opportunity for reaping investment profits!
Chart 4: This long-term chart provides perspective on just how elevated the VIX 'Fear Guage' is right now – higher than all but one time in history.
What's Possible With Quantitative, ETF-Based Strategies
To demonstrate what is possible when applying quantitative, algorithmic-based trading systems using ETFs, here is the chart of our NASDAQ Persistent Profits Strategy since its inception in 2007. As you can see from the upper window in the chart below, the outperformance is striking, recording a 2,084% gain compared to SPY with a gain of 129% during the same period. This model has produced a 27.28% Annualized Return (upper pane) with a Maximum Drawdown of only -13.17% (lower pane).
Our NASDAQ Persistent Profits strategy uses rules-based systems to determine the optimum position between QQQ and TLT.
Conclusion
While it is certainly possible that stock prices will continue higher to the 50% retracement zone in the near term, over the intermediate and longer-term, indicators are saying that a retest of the March lows is likely in the coming weeks. Using robust quantitative indicators configured into composites (we use as many 38 different data sets) to make these determinations, you get emotion-free and bias-free
investment decisions that can significantly reduce drawdowns and maximize gains.
To learn more about the advantages of ETFs over individual stocks and mutual funds, please see this article in our Introduction Section, titled "Why ETFs are Today's Investment of Choice." To learn more about the advantages of quantitative investing, please see our article titled "The Benefits of Systematic ETF Investing."
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