Look Out Below, S&P 500 Showing Signs Of A Major Correction
I spent most of yesterday and last night reviewing price levels of the S&P 500. Many economists and seasoned Wall Street veterans are saying that the S&P 500 has rallied "too hard, too fast" in relation to the economic recovery. My deeper price analysis is showing this narrative to be well supported by technical factors.
A quick note, this analysis was done on SPY, the ETF which tracks the S&P 500 index. I used that because its a tradable instrument and more likely to have a part of people's portfolios.
The above analysis combines both a fibonacci retracement along with support/resistance levels of the S&P 500 dating back to February. If you look at the high of August (circled in red), the market almost immediately denied a move higher above February's high for the year.
One of the most reliable aspects of price action is that price will always retrace. If we look at the entire year from that perspective, it makes perfect sense why the market rallied back to February highs...the market rally from April to August was not a recovery, it was a retracement.
The market rally from April to August was not a recovery, it was a retracement.
Based on this logic, I put together a basic hand-written Monte Carlo simulation of where I believe we go from here for the rest of the year. Those potential paths are highlighted by the letters A-F respectively and I'll explain what would influence the market to take each path.
Path A represents the most optimistic and bullish scenario, it represents the scenario where nothing goes wrong, the market rallies and we finish the year higher.
I see this as the least likely scenario because it just assumes a normal market atmosphere, which this year has been anything except that. I would give this path more credibility if it wasn't an election year and we had a meaningful economic recovery from the virus, but that simply has not happened yet according to the data.
Path B represents one of the more likely optimistic outcomes where we finish the year at February highs, albeit things getting a bit rocky on the way there.
In this scenario, we experience a correction down to 300 level for SPY, where we may potentially bounce off of momentarily. This will be an inflection point for Congress to reconvene on the stimulus bill. If they can pass it fast, the market will rally, the Fed Bubble will expand and we have fighting chance to finish at the February high by year end.
Path C also represents a more likely scenario, however much more pessimistic. This scenario would be likely to occur if congress remains in stalemate on a stimulus bill, but it also includes the potential for market manipulation prior to the election.
Two weeks ago, the Wall Street Journal published an article highlighting the fact that since 1928, the stock market has been a strong predictor of the presidential election going to the incumbent about 90% of the time. Both parties know this, which means that both parties have an incentive to manipulate the market by dumping or buying shares through their super pacs and donors to move the market to their favor prior to November 5th. Whether either party will be more successful doing this doesn't mean much, but you can certainly bet on more volatility, which means we're in for some big swings.
Path C also accounts for the fact that Trump may force Republicans back to the table to just agree to pass the HEROES Act because the market will rally if they do. I would expect this to happen around the fourth week of October since the recency would help Trump's prospects going into November 5th.
Path D represents one of the more pessimistic scenarios, and one which I think is very plausible. Path D combines all the events of Path C, plus the potential for a second wave resurgence of the virus by late October. This is a high possibility because we're seeing other countries such as Israel going into a second lockdown because numbers have been spiking. Path D would also represent a full retest the March lows. This again would make logical sense, because since we already re-tested the highs and couldn't break through, the market now needs confirmation to retest the lows.
Paths E and F are the most dire scenarios. This would represent basically everything of Path D plus accelerating loan defaults leading to more bankruptcies and foreclosure proceedings as courts work through their current case backlogs. The only real difference between E and F is how much the market reacts towards the downside: we could bounce off the March lows, or create lower lows.
I drew arrows downwards after December in these two scenarios because these scenarios have the potential to accelerate and shift COVID risk into the financial sector, and I can't accurately estimate what that damage would potentially be right now because most of the banks have moved their mortgage backed securities off-balance sheet and into SPV's ("special purpose vehicles"). These vehicles allow banks to move their riskier assets off balance sheet to be in compliance with Dodd-Frank liquidity requirements. So unfortunately we can't really see what's in there until they blew up.
These scenarios would be pretty bad going into 2021 because it would be an order of magnitude worse than the 2008 crash. We'd have accelerating mortgage defaults plus a virus resurgence which would paralysis the country into a second lockdown.
In all of these scenarios, I factored in the potential for a late December selloff for tax planning, however, that selloff could be eclipsed if we get news of an approved vaccine. Right now, those prospects seem unlikely, however it's a factor investors must consider.
If I had to pick which scenarios are most likely, I would go with B, C, or D, depending on how October plays out. In all three scenarios, we have a big drop in October, but how Congress responds and how fast they respond will be a heavy factor on where the market goes from there.
My bet is that Republicans will make a deal by late October, the demographics will dump shares the week of the election and we'll get news of a second wave of the virus probably the last week of October. Scenarios A and B would be a retracement down to .618, while C, D, E, F would be further retracements down to the 0.236 Fibonacci level and below. All of these fib levels coincide with a weekly support/resistance we've seen this year.
A quick note, this analysis was done on SPY, the ETF which tracks the S&P 500 index. I used that because its a tradable instrument and more likely to have a part of people's portfolios.
The above analysis combines both a fibonacci retracement along with support/resistance levels of the S&P 500 dating back to February. If you look at the high of August (circled in red), the market almost immediately denied a move higher above February's high for the year.
One of the most reliable aspects of price action is that price will always retrace. If we look at the entire year from that perspective, it makes perfect sense why the market rallied back to February highs...the market rally from April to August was not a recovery, it was a retracement.
The market rally from April to August was not a recovery, it was a retracement.
Based on this logic, I put together a basic hand-written Monte Carlo simulation of where I believe we go from here for the rest of the year. Those potential paths are highlighted by the letters A-F respectively and I'll explain what would influence the market to take each path.
Path A represents the most optimistic and bullish scenario, it represents the scenario where nothing goes wrong, the market rallies and we finish the year higher.
I see this as the least likely scenario because it just assumes a normal market atmosphere, which this year has been anything except that. I would give this path more credibility if it wasn't an election year and we had a meaningful economic recovery from the virus, but that simply has not happened yet according to the data.
Path B represents one of the more likely optimistic outcomes where we finish the year at February highs, albeit things getting a bit rocky on the way there.
In this scenario, we experience a correction down to 300 level for SPY, where we may potentially bounce off of momentarily. This will be an inflection point for Congress to reconvene on the stimulus bill. If they can pass it fast, the market will rally, the Fed Bubble will expand and we have fighting chance to finish at the February high by year end.
Path C also represents a more likely scenario, however much more pessimistic. This scenario would be likely to occur if congress remains in stalemate on a stimulus bill, but it also includes the potential for market manipulation prior to the election.
Two weeks ago, the Wall Street Journal published an article highlighting the fact that since 1928, the stock market has been a strong predictor of the presidential election going to the incumbent about 90% of the time. Both parties know this, which means that both parties have an incentive to manipulate the market by dumping or buying shares through their super pacs and donors to move the market to their favor prior to November 5th. Whether either party will be more successful doing this doesn't mean much, but you can certainly bet on more volatility, which means we're in for some big swings.
Path C also accounts for the fact that Trump may force Republicans back to the table to just agree to pass the HEROES Act because the market will rally if they do. I would expect this to happen around the fourth week of October since the recency would help Trump's prospects going into November 5th.
Path D represents one of the more pessimistic scenarios, and one which I think is very plausible. Path D combines all the events of Path C, plus the potential for a second wave resurgence of the virus by late October. This is a high possibility because we're seeing other countries such as Israel going into a second lockdown because numbers have been spiking. Path D would also represent a full retest the March lows. This again would make logical sense, because since we already re-tested the highs and couldn't break through, the market now needs confirmation to retest the lows.
Paths E and F are the most dire scenarios. This would represent basically everything of Path D plus accelerating loan defaults leading to more bankruptcies and foreclosure proceedings as courts work through their current case backlogs. The only real difference between E and F is how much the market reacts towards the downside: we could bounce off the March lows, or create lower lows.
I drew arrows downwards after December in these two scenarios because these scenarios have the potential to accelerate and shift COVID risk into the financial sector, and I can't accurately estimate what that damage would potentially be right now because most of the banks have moved their mortgage backed securities off-balance sheet and into SPV's ("special purpose vehicles"). These vehicles allow banks to move their riskier assets off balance sheet to be in compliance with Dodd-Frank liquidity requirements. So unfortunately we can't really see what's in there until they blew up.
These scenarios would be pretty bad going into 2021 because it would be an order of magnitude worse than the 2008 crash. We'd have accelerating mortgage defaults plus a virus resurgence which would paralysis the country into a second lockdown.
In all of these scenarios, I factored in the potential for a late December selloff for tax planning, however, that selloff could be eclipsed if we get news of an approved vaccine. Right now, those prospects seem unlikely, however it's a factor investors must consider.
If I had to pick which scenarios are most likely, I would go with B, C, or D, depending on how October plays out. In all three scenarios, we have a big drop in October, but how Congress responds and how fast they respond will be a heavy factor on where the market goes from there.
My bet is that Republicans will make a deal by late October, the demographics will dump shares the week of the election and we'll get news of a second wave of the virus probably the last week of October. Scenarios A and B would be a retracement down to .618, while C, D, E, F would be further retracements down to the 0.236 Fibonacci level and below. All of these fib levels coincide with a weekly support/resistance we've seen this year.
Comment:
Market took the first leg of A, but given the run up, I think we're going to take the crash leg once we hit the 352 mark (double top), then its down to 300 or even 263 if we're looking at Fibonacci's. Either way, crash is imminent. The market has officially lost its mind. It is rallying for no economic reason whatsoever right now. Today is the absolute height of irrational exuberance.
Comment:
My analysis is looking correct, we peaked at 356 before moving rapidly downwards, we already broke through the 50 MA, so the next stop is the 200 MA which is looking around 312, we should bounce off that to 320, but I think we'll break through down to 300 after.