Assessment – The Damage Of The Recent Market Turmoil
As we prepare for market action this week (2/12), we must ask: Was Friday’s (2/9) market rally a real bottom or a fake one?
In comparing Friday’s rally after a -4% selloff on Thursday (2/8) vs. Tuesday’s (2/6) rally after the -4% selloff on “Black Monday” (2/5), we’ll see that Friday’s rally DID, in fact, meet the general real short-term (ST) tactical bottom criteria:
1. Re-tested the bottom and failed to break down.
2. Bounced off of the 200dma.
3. Strong and persistent rally after a big intraday selloff down over -2% (from up over +1% at the open to down over -1% in early afternoon).
4. The unwinding of risk assets was more orderly and systematic.
To know if the recent market bottom will hold, we must also ask: Will the market turmoil over the last two weeks ignite something even bigger in the immediate future?
That answer is NO for the following reasons:
1. There was a real lack of cross-asset contagion, with most of the damage experienced ONLY in the equity and volatility spaces.
2. Fundamentally, the global macro backdrop is still supportive, making it unlikely that the current market correction will deepen further (down -12% to its intraday low) to start a true bear market.
However, the ST tactical market bottom is currently in a fragile state, which makes it still very sensitive to any negative external shocks.
While Monday’s opening is positive, we have to continue to be watchful over the next few days to ensure that the ST bottoming foundation is solidifying.
In fact, this ST bottom rally will likely be slower and a less robust pattern relative to previous ST corrections in the current bull cycle because:
1. The self-reinforcing buying positive feedback loop is temporarily broken due to the implosion of the volatility complex and general de-risking of quant funds.
2. After a surprise, swift, and deep correction, ST market psychology is damaged, forcing dip buyers and value investors to be more patient jumping back in.
3. With the Fed’s strong tightening bias (Fed’s Dudley says drop in stocks is ‘small potatoes’), the market knows that the Fed will not be coming in with any ST policy response.
4. After massive capital inflows into risk assets in January 2018 (on top of the massive inflows in 2017), there is less money sitting on the sidelines with less conviction. Many market players want to see a ST tactical bottom solidify further before they take any action.
Strategic View On The Current Bull Cycle:
Will the recent market turmoil lead to the start of a bear market?
Outside of some external crisis or shock, the answer is NO as the global macro backdrop is still supportive.
With that being said, the current bull market cycle is on a trajectory course to reach a major market cycle top this year (2018) as anticipated:
1. A parabolic market melt-up rally accompanied with a swift and deep correction is a hallmark sign of a major market bull cycle top approaching.
2. Rising interest rates, declining CB (central bank) liquidity support, increased volatility, reduced risk appetite, and tighter financial conditions are fertile conditions for the bull market cycle to top out in 2018.
Strategically, we are entering the bull market phase transition period. The bull market music is still playing, but the tune and tempo are changing. We are still dancing, but must be ready to adjust the dance moves (i.e. more active trading) as the melody changes.
More importantly, it is time to put the beers and cocktails down and begin dancing near the exit door.
-The Market TRANquilizer