Here's How Far the S&P 500 May Fall

I have been asked how low the S&P 500 could go in the coming economic downturn.

In terms of stock market price action, all major economic downturns are merely Fibonacci retracements on the yearly chart.

In fact, we can predict with a reasonably high degree of certainty the bottom for the next recession before it even begins! That's because stock market bottoms are predetermined by past price action. In the case of SPX, the next stock market bottom was predetermined nearly 90 years ago.

I will try to prove this below using the replay function that @TradingView provides for charts.

So let's go back in time.


Here is what the stock market looked like in 1929 right after the Black Tuesday stock market crash.

Around this time, market participants felt not much unlike they feel today: The stock market had been on a decade-long rip higher but just had a bad past several months. For the most part, most of the profits from a decade of prolific growth were intact. Though fear was high and continuing to mount, many market participants still had hope that the stock market would recover and continue its trend higher in the next year. Little did they know that they were sitting on the precipice of the most dramatic crash in stock market history...


To see what happened let's apply Fibonacci levels. See the chart below where I placed log-adjusted Fibonacci levels. (One should always use log-adjusted Fibonacci levels when analyzing the S&P 500 in general, but especially on higher timeframes).

Unfortunately, the stock market would proceed to crash relentlessly for years. Here's what the chart looked like precisely at the stock market bottom in 1931.

The magnitude of the market crash is hard to overstate. Indeed, many people's lives were ruined by it. Some investors who lost everything even committed suicide. At this point, virtually all market participants were certain the stock market would never go back up to new all-time highs. But it's usually precisely at these points of universal despair that significant stock market bottoms form.

Despite all the calamity and then despair, the stock market was merely undergoing Fibonacci retracement on the yearly timeframe. As you can see below, it retraced, and then quickly rebounded.

Now let's fast forward over a half-century to the what's often considered the second-worst stock market crash in history: the infamous Black Monday on October 19, 1987.

To put this date into perspective I've drawn a line up to this level on the 1931 chart.

Let's fill in all the candles to see what happened on Black Monday in 1987.

As you can see in the chart below, during the 1980s, after Fed chairman Volcker successfully contained the inflation of the 1970s, the stock market ripped higher.

However, unbeknownst to many, the stock market was beginning to approach its 2nd Fibonacci extension (or 2nd Fibonacci spiral). These important Fibonacci levels act as magnets to which price is mathematically attracted. As market participants' greed and optimism took hold, the stock market went up parabolically.

Everyone was getting rich.

Derivatives trading exploded because of market participants' extreme greed.

Then, in August 1987, the 2nd Fibonacci extension was reached.

Here's a close-up:

After August 1987, the stock market entered a typically volatile period of the year (September and October). Suddenly, everyone's greed shifted to panic. Everyone wanted to sell all at once. Derivatives trading became chaotic, so much so that the volume overwhelmed the exchanges to such an extreme level that price discovery became virtually impossible.

The stock market crashed.

It caused the highest volatility spike ever recorded. The predecessor to the VIX, the VXO, reached an intraday high of 172.

The VIX today is 28.

The second-worst stock market crash in history following the Great Depression happened exactly at the second Fibonacci extension.

Now let's fast forward to the year 2000. Dotcom stocks were ballooning as market participants began to realize that an e-commerce revolution was happening. Again, market participants' greed and optimism took hold, the stock market went up parabolically.

Everyone was getting rich.

But remember the chart from the Great Depression? See below.

Well, there are two Fibonacci extension levels (2.414 and 2.618) from that chart that were sending a warning nearly 70 years later.

These Fibonacci levels would contain price action of not one but two economic recessions: The Dotcom Bust and the Great Recession

All the chaos of Dotcom companies going bankrupt and of financial services firms collapsing during the Great Recession was contained within two Fibonacci levels that were predetermined over 70 years prior to these events unfolding.

Chaotic and calamitous events that characterize every stock market crash are part of the predictable and orderly of ebb and flow that characterizes Fibonacci extension and retracement. Mathematically, the Fibonacci sequence turns irrational and disorderly numbers into orderly and perfect ratios.


Now fast forward to 2021. Decades of monetary easing have caused the stock market to explode higher, even while volume was shrinking. But yet again, market participants' greed and optimism took hold, the stock market went up parabolically.

Everyone was getting rich.

The stock market had risen so fast and so far that the Dotcom bubble was largely forgotten as stocks of start-up companies with no earnings went to the moon upon initial public offering, and as companies with negative cash flow became more valuable than blue chip companies.

Indeed, the S&P 500 chart was so parabolic that the most calamitous period in the stock market history -- the Great Depression -- was not even visible on it.

Despite not being visible, except on log-adjusted charts, the price action from Great Depression 90 years prior, was again sending a warning that few noticed: the 3rd Fibonacci spiral had been reached.

Despite limitless monetary easing causing the stock market to overthrow the 3rd Fibonacci extension, as usual, this level acted as a magnet for price, and the stock market came back down to it once market participants' greed turned into fear.

The result was one of the worst first 6 months of the year in stock market history.

Indeed, the June 2022 "bottom" occurred exactly at the 3rd Fibonacci extension.

So how far might we retrace in the coming economic downturn? If the 3rd Fibonacci extension fails to support the stock market, then we will likely decline to the 2.618 Fibonacci level.

We are still relatively at a market top, and as usual, at market tops, few market participants accept the possibility that the stock market could ever retrace down so far to the previous Fibonacci level.

Ironically, years later, once the stock market has indeed retraced down so far, few market participants accept the possibility that the stock market could ever extend back up and reach new all-time highs.

This is simply the nature of the endless Fibonacci extension and retracement roller coaster that is the stock market.




For more information about the math and theory behind the Fibonacci spiral, also known as the Golden Spiral, you check out this Wikipedia article on the Golden Spiral: en.wikipedia.org/wiki/Golden_spiral

Comment:

The selling may continue until at least the golden ratio retracement has been achieved. August and September have been months characterized by capitulation.

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Comment:

Now that we returned back to the 3rd Fibonacci spiral, the next phase will be that we drop below this level to form a lower wick on the yearly chart. The yearly chart will tend to want to close near this level. This means that more downside is likely from late September into October, and then price will rise in November and into December to close the year near this Fibonacci level or slightly below or above it. In terms of how low price can drop in 2022 before finding some kind of strong support, keep an eye out for 3566 on the S&P 500. I would be quite surprised if price crashes below this level with no bounce at all. This level is a golden ratio retracement from the COVID bottom to the January 2022 top. If price respects this level strongly, then there is a bull case to be made going into the close of the year. Whereas if price crashes past this level, then I would be quite concerned.

It is my belief that if the S&P 500 does not find its ultimate bottom around 3566, then it will be quite clear that the stock market has begun a years-long process of retracing stock market gains. As always, anything can happen, and there will surely be bull runs along the way. This is not financial advice, do your own research. Don't use anything I post to buy or sell. This is just my open-source journal here. I love seeing charts in the comments, so feel free to drop one!

Comment:

All of this market panic created by fear of spiraling inflation, an energy crisis, a monetary crisis, sovereign debt and bond crisis, war, deglobalization, and climate change, may seem like a lot.

During times like this, it's important to know stock market history. Throughout stock market history things often feel this way. Volatility is common almost every September and October. Indeed the current VIX level is actually quite low compared to periods of worse stock market panic.

While I do see further economic downturn in the future, there are nonetheless great opportunities to invest in beaten-down stocks right now! I am currently loading up on beaten-down stock in my self-directed IRA, which has a time horizon of about 30 years before I start to cash out. In this account, I only ever buy. I never sell stocks from it.

Here are some crashing stocks that look like great long-term investment candidates to dollar-cost average on within an IRA:

SWK
VFC
SMG
MPW
WPC
CHTR
FDX
O
FIS

Could these all go lower? Yes, absolutely. In which case, buy more!

You may ask, but what if some of these companies go bust?!

My answer: That's fine. Investing is not about being perfect, it's about having probability on your side. All you need is for just a few of these stocks to simply recover their losses and the rest can go bankrupt and you'd still be profitable. Most likely, all of these companies will persist and over 10, 20, or 30 or more years, many of them will rise by multiples of where they're trading today. I screened these companies to confirm that they all outperform the money supply over time. So once the Fed does pivot (and it will) and restarts the money printer, these stocks will scream higher.

Finally, you may ask: Why buy now and not later at a cheaper price?

My answer: Well while things can get cheaper, but they also might not. No one ever knows the exact bottom. For a stock like SMG, it has already dropped to a level that has a significant economic downturn priced in. In fact, SMG's drop is equivalent to the S&P 500's drop during the Great Depression on a standard deviation basis. Knowing this makes it a perfect candidate for an IRA.

You should always contribute the maximum to an IRA regardless of if you expect the market to get cheaper. This is because, if the market does get cheaper, you will have a large basket of holdings that you can convert to Roth, and then benefit from tax-free growth. Waiting until the market bottom, assuming one can even predict the exact bottom, is not ideal because you can only contribute a certain amount to an IRA in a given year. Thus, you will not benefit as much from buying right at the bottom, as you would averaging down and accumulating a much larger portfolio and then converting to a Roth at the bottom. The only strategy that is time-tested is dollar cost-averaging for an IRA.

So the moral of the story is that during market crashes there is much opportunity to build wealth, and one of the best means to do so is an IRA.

Not financial advice, just my thoughts.