Martin Zweig, a well know analyst and author of the acclaimed 1986 book Winning on Wall Street once said:
“Big money is made in the stock market by being on the right side of the major moves. The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not”. Martin Zweig
The old Efficient Market Hypothesis (EMH) from the 70’s stated that “prices” (for stocks etc.) reflected all available information and that this information was immediately and rationally determined and interpreted.
If this were true, we would rarely see trends developing – but as you’ll see below, trends do exist. The word “interpretation” mentioned above is subject to our irrational exuberance and other human frailties. We often don’t act rationally, and our decisions are based on long established genetically encoded behavioral “errors”. Investors’ behaviours lead markets to trend. Investments will spend more time trending in one direction than they’ll do reversing course. Price reversals (going from one trend to the opposite trend) often take very little time. Identifying trends and reversals is ultimately what technical analysis is all about. We generally divide trends into three main timeframes as follows:
- Primary Trend – measured in months or years (see below);
- Secondary (or Intermediate) Trend – measured in weeks or months;
- Short-Term Trend – measured in days.
When a market has clearly changed to a long-term downtrend, I generally advise to trim profits, or even sell and invest in a different rising market. I’ve mentioned in several of my previous research reports that markets have been reaching extreme highs and that, as they continued, the risk versus the potential reward was no longer appropriate. Whenever markets are at extremes like they’ve been, they become overly jittery and tend to react aggressively to negative news, whatever the news of the day is. So, we’ve been primed for a correction for quite some time and this is what seems to be occurring now.
The coronavirus will have an impact on the economy and may even throw us into a recession. We’ll have to wait and see what the end result is. We often don’t realize that we were in a recession until later. In my November 4th, 2019 research comment, which I also posted on this blog page, I mentioned the New York Fed Probability of Recession Index. Based on that index, I suggested that we could see a recession by July of 2020. With what’s going on these days, I wouldn’t be surprised if that timing ends up being right.
FAB Indicator
The views I publish are in part based on a technical indicator I created over several years which I refined during my studies for my Chartered Market Technician designation. You’ll see an example of the FAB Indicator in the weekly chart below.
The chart is of the iShares All Country World Index ETF (ACWI) from March 2015 to January 2020. The line is coloured to match the indicator found below it. This makes it easier for non-technical analysts to get a sense of the risk and reward of various markets and investments.
When the indicator is dark green, it means the market is BULLISH (positive) and has a strong probability to continue in an uptrend. However, when the indicator turns dark red, it means the market is BEARISH (negative), and has a strong probability of switching to a downtrend. The grey lines added to the chart above (with small green and red arrows) are support and resistance lines, which helps us see when a market crosses from one trend to another one.
What About the Current Markets?
The following is a daily line chart of the S&P 500 Index from January 2018 to yesterday, February 26th, 2020. I’ve added grey support lines where appropriate.
You’ll see that on February 21st, 2020, the FAB changed to a BEARISH RED and pierced the grey support line, losing roughly 9% since then. The U.S. market has officially changed from an uptrend to a downtrend. Remember – it’s suicidal to fight trends!
Based on several measures that we observe, we may further drop to a level of 2,748 resulting in a loss of 16% from the Feb 21st trigger. If the market continues past this level, then we could drop to a level of 2,584, resulting in losses of over 20%.
If you look back to 2018 on the chart, the last time the FAB triggered a BEARISH RED for U.S. Equities was in October 2018, which was followed by an 18% decline over the ensuing 11 weeks (to Dec 2018). It took 25 weeks to get back to the level reached before the start of the decline. That’s almost half a year with essentially no returns except for dividends.
Here’s another chart – this time for the iShares All Country World Index ETF (ACWI) which is a decent proxy for global equities.
Once again, you’ll note from the above that the FAB triggered a BEARISH RED on February 21st, 2020 and has since lost approximately 7%. Global equity markets are also in a downtrend.
If things continue, we will probably drop to a $70 level, which is 4% to 5% lower from today. If support is nonexistent and we go past that level, we could hit a $63 level with resulting losses from the BEARISH trigger of over 19%, assuming we don’t continue downward.
Whenever the trend clearly changes from an uptrend to a downtrend, it makes sense to at least reduce our exposure to that particular investment and look for one that is in an uptrend. Take for example the SPDR Gold Shares ETF (GLD). Since December 2019 when the FAB triggered a BULLISH GREEN and breached resistance, GLD increased by over 10%.
Bonds and other investments have also behaved similarly to gold over the past several weeks. It’s just a matter of applying intermarket analysis and keeping an eye on charts to capture the major trends.
If your investment advisor is not managing downside risk for you, then you’ll have to suffer market declines and may have to wait several weeks if not months, before being back to the levels we were at recently. That’s a dangerous situation to put yourself in if you’re about to retire, or worst yet, if you are retired and are counting on your investment capital to supplement retirement income.
For further information about our services, please browse this site and contact us if you have any questions. If you are an investment advisor and would like to be added to our member’s list to receive my research reports, please contact me.
Remember, it’s suicidal to fight trends – and right now, we’re in a downtrend. Good luck out there!
Fabien Ouellette
CMT, CFTe, CIM, FCSI
Portfolio Manager
Financial & Estate Planning Advisor
