Risk-tightrope

In last week’s technical review “The Mark Of A Bear,” I stated:

The Bulls have remained firmly in charge of the markets as the reach for returns exceeded the grasp of the underlying risk. It now seems that has changed. For the first time since 2007, as we see initial markings of a potential bear market cycle.”

The problem in stating that we MAY be seeing the initial markings of a potential bear market cycle is that individuals assume this means the markets will crash immediately. When such an outcome does not occur, the analysis is presumed wrong. 

However, it is specifically that denial that leads investors to jump back into the markets just before the ensuing crash occurs. This is known as the “sucker’s rally.”  As shown in the chart below, this may be the setup that we are currently witnessing.

SP500-Technical-090815

 

With relative strength trending lower, volumes on advances weak and sentiment poor, it is highly likely that any bounce over the next few weeks will likely fail.

A Look Backward

One advantage of technical analysis is the ability to look backward to get a glimpse at how the “madness of crowds” reacted in previous similar situations. While the past is by no means a perfect predictor of future outcomes, human nature tends to be quite insightful. 

2000

The chart below of “dot.com” bust shows many similarities between the behavior of investors then and today. 

 

SP500-Technical-090815-3

 

As shown, during the market advance in 1999 the previous bullish trend support moving average tended to confine pullbacks in the markets. This supported the notion of “buying dips” as each decline from overbought (red dots above and below) to oversold (yellow dots) conditions set up the next rally in the ongoing bullish trend.

However, it is the TREND that we are most concerned with. 

Notice that beginning in August of 2000, the dynamics of the market changed. After breaking previous support levels, the markets retested the lows of a year earlier. (Sound familiar?) But, the subsequent bounce failed to move above what was previous the long-term bullish support moving average. 

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