“That correction started on Monday with the week ending in 5-straight down days which is the worse slide since February.
However, while that sounds terrible, the total decline for the week was just -1.69%. Yes, that’s it, less than 2%. While CNBC probably ran their “Markets In Turmoil” segment, traders huddled over candles and incense chanting incantations at the Fed for more accommodation.“
The hope, of course, was that retail investors would step in to “Buy The Dip,” as they have done repeatedly this year, at the 50-dma. But, interestingly, such was not the case with the finishing the week down, as shown below.
If you back the time frame up a bit, you kind of need to squint to see the correction.
Perspective is always important.
Waiting On The Fed
We can attribute the weakness on Friday to “quadruple witching,” where every type of option (stock index futures, stock index options, stock options, and single stock futures) all expired simultaneously.
However, history is also not on the market’s side, with the averaging a 0.4% decline for September, the worst of any month, according to the Stock Trader’s Almanac. Friday, in particular, began a historically weak period for stocks as those September losses typically come in the back half of the month.
Also, the markets are a bit nervous about the Fed’s this coming week with an announcement of “tapering” asset purchases expected.
While all that sounds terrible, the total decline for the last two weeks is just -2.4%. Yes, that’s it, just 2.4%. As noted, it looks much worse on a short-term chart due to the low volatility advance this year.
As noted last week, the sell-off to the 50-dma was not a surprise.
“With sell signals in place, volume rising, and breadth weak, a retest of the 50-dma early next week will not be a surprise. The question will be whether traders show up again, as they have done every other time over the last 6-months to ‘buy the dip.’
As shown, the market remains well confined to its rising trend with support sitting at the 50-dma. Volatility did pick up late last week as volume spiked suggesting more selling pressure on Monday.
With the market very oversold, a counter-trend bounce next week will not be a surprise. However, if the market fails to hold the 50-dma, the risk of a more substantial correction is likely.
When looking at long periods of market history, the current market stands out as an apparent anomaly. Many younger investors in the markets today are unaware of the “melt-up” in prices and the Fed’s naivety of the laws of physics. After more than a decade of rising prices, accelerating markets seem entirely normal, detached from underlying fundamentals. During these periods, investors create new acronyms like “TINA” and “BTFD” to rationalize accelerating prices.
However, a more extended look at price history suggests the current market environment is anything but ordinary. More importantly, the “”created by the Federal Reserve’s continuous bailouts have put individual investors at significant risk.
In the short term, like the chart above, prices don’t seem that extraordinarily stretched. However, this is because the chart lacks context from a historical perspective. Once we look at the market from 1900 to the present, a different picture emerges compared to its exponential long-term growth trend.
Usually, I would present a long-term chart like this using a log-scale which reduces the impact of large numbers on the whole. However, in this instance, such is not appropriate as we examine the historical deviations from the underlying growth trend.
What you should take away from the chart above is apparent. Investing capital when prices are exceedingly above the underlying growth trend repeatedly had poor outcomes. Investing capital at peak deviations led to very long periods of ZERO returns on capital. (Interestingly, as the Fed became active in the markets, the periods of zero returns got cut in half.)
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