Bear Market Rally Teetering

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Market participants are wondering right now if we are merely in a bear market rally or if this is the beginning of a new long-term bull run.

I thought I would write a post to share my thoughts.

First, the chart above: This is a weekly chart of the S&P 500 ETF ( SPY ) with Fibonacci levels applied. I drew Fibonacci levels from the January high to the June low to identify areas where the price of SPY may be resisted or reverse back downward. The chart is adjusted for dividends and is based on a log scale. I also placed arrows where Fibonacci levels may have acted either as support (up arrows) or resistance (down arrows).

While anything can happen and it would be foolish to make a call for certain, I do genuinely believe the following:

Regardless of how high the S&P 500 rallies, at some point in the future we will likely see the June bottom again.

This is because the June bottom is far more important than most people realize, as I will explain below.

Back on June 17th, the exact day of the bottom, I noted that SPY was likely bottoming. My charting analysis told me we were likely in the lower wick formation of the monthly candle at the time, so I knew a bottom was imminent. See the below post.

In early July, I also explained that the bottom was significant. See the below post.

We are currently sitting on a major level in stock market history. See the below chart.

The chart above is a yearly chart of the entire 150 years of SPX price data that Trading View provides. When one analyzes the chart as if it were a shorter timeframe chart, one will see that we are teetering right on the third Fibonacci extension of the Great Depression high. That is to say, when one draws Fibonacci lines from the lowest price ever for the SPX up to the Great Depression peak and then applies Fibonacci extensions, one will see that the June bottom was precisely on the third extension of the Great Depression. (Some call it a Fibonacci extension , some refer to it as a Fibonacci Spiral, and others refer to it as a Golden Spiral. Regardless, it is a very important level.)

For more information about the math and theory behind it, you check out this Wikipedia article on the Golden Spiral: https://en.wikipedia.org/wiki/Golden_spi...

These spirals occur at points in time when markets can undergo the most dramatic declines. This occurs mathematically in the form of price unraveling to a previous Fibonacci level.

In fact, very few people know that Black Monday (the 1987 Stock Market crash) occurred at the second extension of the Great Depression peak. Computers and smart money were detecting this Fibonacci level and likely led the initial phase of the sell-off, which spiraled into a panic sell-off.

The above monthly chart from 1987 shows that price tried to surpass the second Fibonacci extension but failed to close above it and was repelled back down.

Fast forward to the present time, the Fed Reserve's limitless quantitative easing propelled us abruptly above the third Fibonacci extension in the beginning of 2021. This important Fibonacci level actually held as support for both the 2021 low and the 2022 low (so far). See the charts below which show that the June bottom landed precisely on the 3rd Fibonacci extension .

On a yearly chart, (although the yearly candle has not been completed yet), you can see that we are sitting precariously on the 3rd Fibonacci extension with a bearish hammer .

This is quite concerning because it is occurring while we are on the verge of a significant recession. While I cannot explain all the reasons why I believe a significant recession is underway in this post, I have links to my prior posts explaining all the chart findings that lead me to this conclusion. You can refer to these links below.

I find it concerning that so many market participants are buying into a rally while the yield curve is so inverted. Indeed, the yield curve is the most inverted it has ever been since data became available in the 1980s (as measured by a 10Y/2Y ratio). See my post below.

Here's why I believe this rally is occurring. This rally was caused by two main types of market participants:
  • Marginally informed market participants who think that inflation has peaked. While inflation very likely did peak locally, there are worrying charts that suggest elevated inflation will be persistent. Some commodities have broken out on their yearly charts, which can provide a tailwind for higher prices for years to come. So far there is no evidence in the charts that inflation is dropping precipitously enough to warrant a sudden pivot to easing by the Fed. I believe these marginally informed market participants may get whipsawed if inflation surprises back to the upside in the months or years ahead.
  • Shorts are getting squeezed. There were plenty of signs in June that the markets needed to rally back up, no matter how bearish the long-term outlook. Many shorts missed these signs or fell victim to smart money misleading them. (Recall that right before the June low, Jamie Dimon warned that a hurricane was coming. Although this is actually true, his timing was likely not coincidental. Smart money loves to trap shorts right at the bottom and make fear-inciting statements when fear is already extreme. Basically, it's squeezing every penny out of uninformed market participants. Sadly, right at the January high Jamie Dimon said the opposite: Recall that in January 2022 he said that he sees the strongest growth in a decade. Again, trying to trap longs at the very top to squeeze every penny out of them. Never trust statements from anyone, unless they can back it up with a chart!). So we have been seeing shorts getting squeezed since June and this short squeeze has propelled the stock market higher at an unnatural and unwarranted rate.

Technical reasons that I remain neutral with a bearish bias include:
  • The weekly stochastic RSI is over-extended to the upside and ready to oscillate back down. While it's possible that price can continue higher or consolidate, despite a declining stochastic RSI , the risk-to-reward does not support rushing into long positions at this point in time.
  • The weekly candle is still within the Ichimoku Cloud which can act as resistance. See chart below

Other reasons that I remain neutral with a bearish bias:
  • From late August through mid- to late-October stock market returns have historically remained muted or have declined.
  • While some can argue that the VIX has broken down its trend line , I remain cautious whenever the VIX and the VVIX are so suppressed to the downside going in the August to October timeframe. This is typically a volatile part of the year. Few people noticed that last week, the weekly RSI of the VIX was the lowest in nearly a decade. This does not make any sense. Being a gauge of fear, I find it hard to believe that the fear among market participants last week was the lowest in nearly a decade (from a weekly RSI perspective). I believe that the VIX has been artificially low lately, and although I can only speculate why, I know one thing for certain: the risk-to-reward does not support entering a whole bunch of long positions at this time. Do not get caught up in the FOMO.
  • The FED is only now just beginning to accelerate the roll-off of assets from its balance sheet . It's hard to imagine this action facilitating a bull run that breezes past new all-time highs. The value of the FED's assets is equal to a very sizable percentage of the total stock market capitalization. Rolling these assets off its balance sheet will de-leverage risk assets. Market participants buying into a rally as the Fed accelerates balance sheet roll-off is essentially fighting the Fed in my opinion. The Fed has only rolled off about 1% of its balance and we had one of the worst first 6 months of the year in stock market history.
  • Finally, as noted above the yield curve has inverted. This means we are in a late-cycle rally. So if I am to add any longs, it will be in sectors that do well in the late cycle: Utilities, Telecom, Healthcare, and Consumer Staples. With that said, I will play very defensively and use fairly tight stops since many risk assets are still historically overvalued and overbought. I will look for strong bullish setups in only these sectors. I also see U.S. Treasuries as attractive if the Eurodollar Futures and the terminal rate remains steady, and assuming the Fed does not get crazy with its balance sheet roll-off.

In summary, virtually all of the charts I have seen show that there will likely be a significant recession in the coming year(s). Be skeptical of strong rallies while the yield curve is inverted. Trade safe, never trade on emotion, and have a plan before you enter into a trade. Good luck with your trading!
Comment: Although it was hard to go against the prevailing sentiment, in this post near the August peak I noted that at some point we would come back down to the June bottom. It happened even quicker than I anticipated which is concerning. Unless the S&P 500 finds its ultimate bottom near 3566, then the evidence that we're not undergoing a major stock market retracement on the highest timeframe becomes quite scarce.

Indeed, some of the growth stocks that collapsed in late 2021 into 2022 look like they've jumped S-curves on their inverted, log-adjusted charts. If these growth stocks only rise to the golden ratio of this move downward and then begin to fall again, then it is quite concerning to me from a mathematical perspective. The fact that prices could move down so extremely and yet PE ratios still be above the Great Depression peak is totally surreal, and is a sign of just how big of a bubble limitless monetary easing has created for the stock market. What continues to concern me is when earnings decline rapidly due to the current monetary tightening. This process can lag 3 or more quarters after tightening begins before earnings fully devolve to a new lower equilibrium.

Therefore it's hard to imagine a strong bull market rally that blasts through new all-time highs in the near future. Although the stock market is forward-looking, it's not so forward-looking that it goes up before even earnings start coming down...

As a disclosure, I hold neither shorts nor longs in the S&P 500 right now. My analysis here is as objective as I humanly can be.

Disclaimer: This post is not intended to be financial advice. I am not a certified or professional financial advisor. Trade at your own risk.

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