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Guest Post: How An Equity Market Prices In Recession

Tyler Durden's picture




 

From Tony Pallotta of MacroStory.com

How An Equity Market Prices In Recession (Updated)

Recently I compared the 2007 equity topping pattern to that of the current market.  The premise being today as in 2007 the US economy is quite possibly entering economic recession.  Long gone are the days of equity markets being forward looking as proven in 2007 when they peaked just two months before contraction began.  A similar pattern is also playing out in the 10 year treasury.

I suspect a topping market is more a function of psychology and less technicals or macro data. The money making bull is slowly dying while the bears are eager for their turn to shine.  The result of this clash of views and buying power is dictated more by emotional, whipsawing action where convictions in one's position and volatile price action make coexistence difficult if not impossible.

In the original post the question was "are we forming Point E."  Well it appears Point E has in fact been formed and the pattern continues to play out almost text book.  Some will argue in 2007 we were trading below the 200MA for example but I reiterate topping patterns may be more psychological and less technical in nature.

  • In comparing the two patterns what's most interesting is that "last dash for yield" from Point D to E.
  • In 2007 the SPX traded 117 points or 8.3% higher in 11 days while breaking the downtrend.
  • In 2011 the SPX traded 98 points or 7.8% higher in 14 days while breaking the downtrend.
  • The last piece of the puzzle would be Point F (an appropriate label) where markets attempt once last rally while the macro data finally confirms what many had feared, that this soft patch is anything but "transitory."

 

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Wed, 07/13/2011 - 19:23 | 1454091 slaughterer
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So, in other words, risk on for about 4 days as the market tries to test E again.  Then point G = goodbye market.

Wed, 07/13/2011 - 19:29 | 1454122 candyman
candyman's picture

What ever happened to green shoots, I have not heard the term used it feels like years, and we're near the highs, WTF?

Wed, 07/13/2011 - 20:44 | 1454412 10kby2k
10kby2k's picture

The green shoots are full blown trees which have pretty much been harvested for printing purposes.

Wed, 07/13/2011 - 23:11 | 1454875 jeff montanye
jeff montanye's picture

i like your metaphor.  point f is the ceiling deal, right?  rally for a week, squeeze the shorts, then cliff dive.  or as john hussman said, wylie coyote holding an anvil a step beyond the lip, and we're all, like, wondering what could be next?

Thu, 07/14/2011 - 07:35 | 1455382 cahadjis
cahadjis's picture

+16Trillion

Thu, 07/14/2011 - 07:10 | 1455332 goldenbuddha454
goldenbuddha454's picture

I think they said green poops.  Like a goose makes.

Wed, 07/13/2011 - 20:18 | 1454314 mayhem_korner
mayhem_korner's picture

A nice fat 430K print on tomorrow's 8:30 EDT IJC report just might pull the floor boards...

Wed, 07/13/2011 - 19:25 | 1454111 caerus
caerus's picture

IMHO if ES breaks support around 1260ish we may have a very impressive triple top/head shoulders confirmation...point E indeed....bravo (maybe)

Thu, 07/14/2011 - 07:13 | 1455339 goldenbuddha454
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I see a falling knife pattern beginning shortly after August 2nd when no budget has been agreed to and Moody's downgrades U.S. to junk.

Wed, 07/13/2011 - 19:35 | 1454151 slaughterer
slaughterer's picture

Have you investigated the pattern overlap with the equity markets now and those of 1999? I have. This comparison yields an entirely different picture.  

Wed, 07/13/2011 - 19:51 | 1454226 MacroStory
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tthere wasnt a recession in 99  

Wed, 07/13/2011 - 23:17 | 1454892 jeff montanye
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another difference is that, properly viewed, 2000 to 2007 was a massive topping pattern, even a bear market rally as nasdaq did not confirm (although wilshire did).  so 2007 and 2011 share intriguing technical (as well as fundamental) characteristics that the all time grand super cycle top (i don't know what i'm talking about but i love the language) would not exhibit.

Thu, 07/14/2011 - 03:23 | 1455213 Sudden Debt
Sudden Debt's picture

ever heard of : PARTY LIKE IT'S 1999!

That's because it was the best year ever for the nasdaq and stock market in general.

 

Wed, 07/13/2011 - 19:45 | 1454199 caerus
caerus's picture

Yes...prob is it's more of an art than a science (and i hate that cliche)  but if I had to compare apples to oranges ('99 to '11) i would say that in '99 we had more of a big rounding top pattern...I'm not saying I know the ES will tank...if I did I'd prob keep it to myself...this just looks too textbook.  I lost my ass betting on this a few months back so believe me im not doing anything till i'm sure.  I hold ZERO equities atm I'm short ZERO equities at the moment.  This just looks like a triple top that started in Jan 2011...just about he right duration too. 

Wed, 07/13/2011 - 19:50 | 1454223 slaughterer
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I like to look at the end of 1999 to get a premonition of the QE3 phase for this year.   1999 popped in July then rounded in fall until the magnificent winter rally.  But yes, what we see right now seems like a classic triple top starting in January.  Just seems however that the market has been headfaking these patterns for the last three years, and just when you think you got it confirmed and lay dollars down on the table, the table is turned.  

Wed, 07/13/2011 - 19:57 | 1454250 caerus
caerus's picture

I agree completely...that's why I'm neither long nor short r now (cept PMs and Oil and Agriculture soon)  All I know is looking at the charts, the clear uptrend after Jackson hole is over, the ES is moving sideways but that cant last forever...break to the upside?  Seems unlikely given macro conditions...but that's just my opinion

Wed, 07/13/2011 - 20:56 | 1454448 ihedgemyhedges
ihedgemyhedges's picture

...that's why I'm neither long nor short

That explains my problem to the core.  My current wife, number 3, doesn't like me being average..............................First 2 didn't care for it either.....

Oh wait, am I on the wrong board????

Wed, 07/13/2011 - 21:05 | 1454480 caerus
caerus's picture

lol should've seen that one

Wed, 07/13/2011 - 23:22 | 1454900 jeff montanye
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again, after "shorty's bar a" it's girth not length.

Wed, 07/13/2011 - 19:51 | 1454228 kito
kito's picture

Sign, sign, everywhere a sign
Blockin' out the scenery, breakin' my mind
Do this, don't do that, can't you read the sign?

Wed, 07/13/2011 - 20:01 | 1454269 caerus
caerus's picture

right on!

Thu, 07/14/2011 - 01:10 | 1455094 RockyRacoon
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Far out and groovy to be sure.

http://www.youtube.com/watch?v=D59ZWa8ehgI

Thu, 07/14/2011 - 00:30 | 1455046 francis_sawyer
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& the sign said... smiley blue shirt people...

need not apply...

 

Wed, 07/13/2011 - 20:10 | 1454294 rocker
rocker's picture

This will be the ultimate test of the Bernanke.  Time will tell.  Kind of interesting that the only thing working today were commodities.

Even Robo's CMA that was bragged as showing strength of few weeks back was on the 52 week low list.

Tony, Great Job on the Charts.

Wed, 07/13/2011 - 20:17 | 1454311 FreedomGuy
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What is a fund that shorts or bets against the market? I am not enough of a trader to be very good at shorting.

Wed, 07/13/2011 - 20:24 | 1454337 caerus
caerus's picture

Well...you got the QID, SDS, TWM, DXD which are leveraged short ETFs on the major indices, or you could buy puts on the indices, or you could go ahead and short names outright but really if you don't have experience I'd just stand back and watch then go long at the bottom...the ETFs I mentioned are leveraged and you could get screwed, also you can't short outright unless you've got a margin account so it's prob safer to just wait.  Oh btw there are unleveraged short ETFs which I can't remember atm so google that...If you must short then be prepared to flip that quickly...especially the leveraged ETFs

Wed, 07/13/2011 - 20:27 | 1454349 FreedomGuy
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Guys like you are one of the things I really like about this site. Thanks for the advice.

Everything is a political economy now and betting against government doing the right thing is a pretty good bet.

"Government will do the right thing once it has exhausted all other possibilities."

     -Winston Churchill

Wed, 07/13/2011 - 20:31 | 1454361 caerus
caerus's picture

Thanks man...good luck!

Wed, 07/13/2011 - 20:39 | 1454392 poor fella
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  The Bernank and SDS knocked my dick 'n the dirt bigtime. IF a downward trend is ever allowed, or things get so scary people are worried about not receiving paychecks or transports aren't taking credit (similar to Lehman collapse and credit freeze) - might be the trick. But as a 'things look shitty, I bet they lose control' play - the rules are the only thing 'transient' - and rule changes will ALWAYS hurt YOU.

Wed, 07/13/2011 - 20:48 | 1454420 caerus
caerus's picture

Ok so what did Livermore say?

First, do not be invested in the market all the time.  There are many times when I have been completely in cash, especially when I was unsure of the direction of the market and waiting for a confirmation of the next move...

- Jesse Livermore  Reminiscenses of a Stock Operator

Even if you don't agree with him...the book is still a hell of a read

Wed, 07/13/2011 - 23:55 | 1454967 jeff montanye
jeff montanye's picture

it is a wonderful, wonderful book.  

re short etfs: agree with the comment above, especially for the novice, avoiding leverage, short sales, futures and options.  i speak from bloody experience having been on the right side of black monday '87 but not much after that.  i hold sh, an inverse (no leverage) s&p 500 etf, since late '09, spring '10 and '11.  was green briefly about a year ago.  still holding and down about 20% (added about 7% monday).  considering the adverse market action to date (and the (negligible) dividend), i'm not dissatisfied with the product (and everyone told me it wasn't a long term asset).  

Thu, 07/14/2011 - 01:13 | 1455098 RockyRacoon
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Wisdom from Jesse:

What beat me was not having brains enough to stick to my own game – that is, to play the market only when I was satisfied that precedents favoured my play.  There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time.  No man can have adequate reasons for buying or selling stocks daily – or sufficient knowledge to make his play an intelligent play.

Thu, 07/14/2011 - 03:09 | 1455207 Tense INDIAN
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"The reason is that a man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do. That is why so many men in Wall Street, who are not at all in the sucker class, not even in the third grade, nevertheless lose money. The market does not beat them. They beat themselves, because though they have brains they cannot sit tight."

 

Jesse Livermore

Thu, 07/14/2011 - 06:44 | 1455310 WonderDawg
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There are also bear funds, like Gabelli Comstock Capital Value, that you can play if you aren't comfortable with the short ETF's or shorting individual stocks.

Wed, 07/13/2011 - 20:25 | 1454340 FunkyMonkeyBoy
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gold and silver.

Wed, 07/13/2011 - 22:17 | 1454729 fuu
fuu's picture

...bitches!

Wed, 07/13/2011 - 20:50 | 1454365 poor fella
poor fella's picture

A triple top, QEIII, 3 years since the recession's end, and three years into a presidential term - 3's a charm? Doubt it, like when 'green shoots' sounded ridiculous (~3 quarters); repeating 'QE', 'transitory', 'soft patch', 'increasing earnings', 'emerging markets', and 'all_the_other_b.s.' - is going to start pissing people off. QE7 is completely out of the question, that extra syllable really drives the nail.

Wake me when the 10 year is sub 2% because I'll know reality finally hit the carbon-based 'investors' that still think the market is anything but a manipulated wealth-distribution device. I look forward to trading again - but doubting that day will ever come... as it stands, the markets, as a place to invest (using research), is completely broken. Really rather sad. People can still go to the casinos with their 'investment' money. 401k and Craps Table - synonyms?

Wed, 07/13/2011 - 20:40 | 1454382 Boston
Boston's picture

A similar pattern is also playing out in the 10 year treasury.

So you're bullish on the 10-year?  If so, the challenge for long-biased folks (like me) is that we're starting from already depressed yields (2.89%) unlike the starting point in late 2007 when they were much higher.  So if we entered a full blown recession, you're talking a "dip" down to at least 2.5%, and maybe even 2.0%.

I've ridden the 10 year from 3.6% to 3.0% and the current risk/reward is far less attractive today, especially with the added $trillions in debt, the massive deficits going forward, and the threat of QE3 (which will drive up yeields again).

I'll take my chances---from the long side---at the shorter end of the curve (2-3 year) and revisit the 10 year should it get hit with a multi-week panic sell-off.

Wed, 07/13/2011 - 20:54 | 1454439 MacroStory
MacroStory's picture

I'm not saying anything about the 10 year just that a similar pattern played out in 2007 but yields peaked well before the recession then as in prior recessions. When more than one market (equities and bonds) follow a similar pattern then the strength of that pattern is greater in my opinion.

Wed, 07/13/2011 - 21:19 | 1454533 Beancounter
Beancounter's picture

Last year when Liz Ann Sonders said "no double dip" I started to lighten up on positions.  She's the perfect contra indicator.  

Wed, 07/13/2011 - 21:49 | 1454632 Yen Cross
Yen Cross's picture

 Well at least the bottom channel is a more accurate fit on the 11 chart, although I may have drawn it off of the August 2110 bottom before the uptrend start, as opposed to the B-1i upmove. To each their own though.  The charts are uncannily similar.

Wed, 07/13/2011 - 22:38 | 1454794 Juice Box
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Everyone on earth is either poised for a big drop or a big rise in equity prices.  I tend to think that we will see neither (at least in dollars).  I feel we are headed for a stealth bear market whereby stocks trade sideways to slightly down (down only 5-10%), but the dollar falls 15% in value.  Now to the average 401K investor stocks are not losing much value, but factor in the your loss of buying power they are losing over 20%).

As the dollar continues its Bataan Death March to US Dollar Index 64, stocks will be buoyed by the weakening dollar.

Sometimes its not all up or down.  Sometimes equities just trade sideways in one big financial jerk-off that kills momentum players.  Thats what this market looks like it might become. 

 

Wed, 07/13/2011 - 22:58 | 1454854 Tater Salad
Tater Salad's picture

Couldn't disagree more Juicy Juice.  I think there is far too much leverage and liquidity in this thing for this to end well.  Even if we don't get a massive pull back into the fall months, I still think the volatility is going to be jaw dropping, perhaps everywhere including the metals.

 

Wed, 07/13/2011 - 23:43 | 1454946 Juice Box
Juice Box's picture

Time will tell Tater, but the only thing I feel certain about is the failure of the dollar.  After all, how can it rise?  It cannot even muster a half decent rally in a Eurocrap crisis.  If the dollar loses 15% of its value, do you really think European investors will not see the cheaper price of a company like Coca Cola, Internation Harvester, etc...  Hey, I think stocks are a con game right now too, but if the dollar tanks it will create buying opportunities for someone.  Not every currency is depreciating as fast as ours.  This will provide a boost for even a sick market like ours.

I think everyone at the Fed and Obama Admin wants a cheaper dollar in the failed hope that it will spur exports.  They just don't understand that it takes a shitload of time to increase your exports - and its damn tough to do.  All these counties that took away our industries are not as stupid as the U.S. was.  They will fight to maintain their manufacturing base and will not allow it to be returned to the U.S.

This is the final stage of the great ripoff.  We have exported our manufacturing and jobs abroad over the last 50 years, and now it is time for the final act - the destruction of your savings to currency depreciation.  In this kind of period having money in equities is slow death as financial assets never track currency depreciation very well.  Only those things you can hold or lean against maintain their value.

Wed, 07/13/2011 - 23:48 | 1454959 Yen Cross
Yen Cross's picture

 Nice post Juice Box... YEN.

Wed, 07/13/2011 - 23:55 | 1454980 Juice Box
Juice Box's picture

Thanks Yen!

One parting thought: Stocks in Zimbabwe did not lose value when their currency collapsed - in Zimbabwean Dollars.

Thu, 07/14/2011 - 00:31 | 1455022 Yen Cross
Yen Cross's picture

  My OXm are stable as well.   Listen to TYLER! Listen to Slewie, and 777...  when those 2 are done going "KILL BILL" on ya. We will teach you charts and will be eligible to buy (OXm)    YEN   Anyone catching the E/U ready to  cave in s/t/

Wed, 07/13/2011 - 23:02 | 1454861 H H Henry P P P...
H H Henry P P P Paulson's picture

If QE3 happens, the this chart forecast for an SPX top becomes defunct?

Wed, 07/13/2011 - 23:11 | 1454878 caerus
caerus's picture

imo most likely...there have been plenty of broken reversal patterns in the past few months...like I said I lost my ass.  but maybe...just maybe...Qe3 happens after a nice tank

Thu, 07/14/2011 - 01:16 | 1455101 RockyRacoon
RockyRacoon's picture

Look at the bright side:  Your gold Eagles are holding up well!

Wed, 07/13/2011 - 23:46 | 1454955 AldousHuxley
AldousHuxley's picture

Equity markets are not pricing in recession. Nobody is pricing in anything. People are gambling on one factor only: QE or no QE.

 

you can price in recession all you want but come QE3, equity will rise. You can beat Fed at their own game. You just have to let the Fed lose all credibility and destroy itself with uncontrolled monster they have created.

Wed, 07/13/2011 - 23:50 | 1454966 SAME AS IT EVER WAS
SAME AS IT EVER WAS's picture

@Tony Pallotta, The "reason" for the 2007-2009 transfer of wealth, plan to keep people from retiring do to labor force demographics, Transition of new TBTF banking overlords, etc...,etc.., was the unreal estate greed bubble or "black swan". For a market crash of the 07-09 magnitude or greater which many are calling for there will need to be an even "Blacker swan" than the last (engineered ponzi pyramid) "bubble". What will it be? I have two neighbors, one works for UPS, the other fedex, both neighbors say they are (and hve been all along) so swamped with "work" they can barely keep up with the demand to ship and deliver goods for their clients. Besides a nation or state defaut (which if it happens will be above and beyond simple greed )or war, what is this swan going to be?

Thu, 07/14/2011 - 06:24 | 1455286 AldousHuxley
AldousHuxley's picture

black swan #1: reports come out saying nobody uses facebook anymore. Facebook's $100B valuation drops to that of Myspace $3M. There goes web 2.0 bubble deflation.

 

black swan #2: Iran succeeds in building nukes by August, saudis follow. nuke war between the two. crude prices skyrocket.

 

black swan #3: crazies assassinate bernanke / obama.

 

black swan #4: the big one strikes in california, takes out silicon valley databases and million dollar home values drop even more.

 

black swan #5: civil war within Euro countries. Euro breaks.

Thu, 07/14/2011 - 06:26 | 1455288 AldousHuxley
AldousHuxley's picture

oh and of course black swan #6: flash crash across major markets

Wed, 07/13/2011 - 23:53 | 1454971 ebworthen
ebworthen's picture

 

When the markets, the government, and the economy do not consider the middle class backbone of the society they fail to predict anything other than delusion and the past.

 

Thu, 07/14/2011 - 01:02 | 1455086 e_goldstein
e_goldstein's picture

bwha, bwah, bwah... tis hard to be the banksta's niggah.

 

Thu, 07/14/2011 - 01:10 | 1455092 NOPOMO
NOPOMO's picture

Soon the Great Casino will be about finished.  Poof...not to be seen again for 30 years.

Don't think it will happen?  Try your hand and find out.

Thu, 07/14/2011 - 02:35 | 1455167 oldman
oldman's picture

Tyler,

Thanks for the effort, but I have difficulty believing that this market is predictable.

We have never had a market in a 'recession' that was so flush with liquidity, indeed, even awash with free 'money' where one could play the market freely and collect interest from the fed on reserves that are as volatile as the pm's were historically.

This may seem a little academic, but I do not see anything in our history that compares with this market.

I wish you a lot of luck on this because its you

thanks for all you do

Thu, 07/14/2011 - 03:03 | 1455202 myne
myne's picture

Check out how perfectly rounded the MACD black days are in 2011.

Very interesting.

Thoughts anyone?

Thu, 07/14/2011 - 07:46 | 1455402 Stellar
Stellar's picture

Does this not place the recession days before August 2nd, haha

Thu, 07/14/2011 - 08:24 | 1455482 orangedrinkandchips
orangedrinkandchips's picture

Top or not, the volatility and the "ill show you" type of makret. Nazi/drug cartel in nature, meaning if you take it down 1% we will take it back up 2% and you will like it spaulding.

Fri, 07/15/2011 - 14:02 | 1460244 Tigre Tigre Tigre
Tigre Tigre Tigre's picture

A notable difference in the chart is that the 2011 E is higher than A, whereas the 2007 E was lower than the A.  So while a big pullback is likely, it's less likely to follow the scenario given above.

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