The S&P 500 Is Now At Extremes

Tyler Durden's picture

Submitted by Lance Roberts of Street Talk Live blog,

Today's chart looks at the market from a technical perspective.  While there are a plethora of Wall Street analysts calling for much higher levels for the S&P 500; most of these calls are based simply on the belief that the current trajectory must continue indefinitely.  While you certainly cannot "fight the Fed" the underlying fundamentals and economics that support the markets long term are not present for the party.  What is very important to understand, and can be clearly seen in the chart below, is that despite repeated calls for "ever rising" stock markets in the past eventually left investors devastated.  Markets do not, and cannot, continue indefinitely in one direction. 

Market prices are subject to gravity (the long term moving average) and the longer the duration of the moving average the greater the "gravitational pull" that exists.  One way to measure extremes of price movement is through the use of standard deviation.   One standard deviation from the mean (average) encompasses 68.2% of potential outcomes within a given distribution of data which, in this case, are market prices.  Two standard deviations encompass 95.8% of all potential outcomes while three standard deviations encompass 99.8% of all potential outcomes.

The chart below shows a MONTHLY chart, which is a very slow moving analysis, of the S&P 500 overlaid with Bollinger Bands which represent 2 and 3 standard deviations of a very long term (34 month) moving average. 


At the peaks of the "Internet Bubble" and the "Credit/Housing Bubble" the market never got significantly above 2-standard deviations.  Today, we are encroaching well into 3-standard deviation territory.  Standard deviation analysis tells us that roughly 99% of the potential movement in prices, from the bottom of the correction in 2011, has been achieved.  Furthermore, the extension of the market above the long term moving average is also at levels that have previously been associated with major market tops.

The top graph is a very long term (150 month) measure of overbought and oversold conditions.  It is also warning that the current market environment is stretched very far and that further gains are likely to be limited without a correction first. 

However, therein lies the potential problem.  Looking back at the markets during a bullish trend the market is usually contained between the long term moving average and 2-standard deviations above the mean.  However, when the extension is above the long term mean subsequent corrections are generally more associated with mean reversions.  A mean reversion is where prices fall an equal distance in the opposite direction or well below the long term moving average. 

The current level of overbought conditions combined with extreme complacency in the market leave unwitting investors in danger of a more severe correction than currently anticipated.  A correction to the long term moving average (currently around 1350) would entail an 18.5% correction.  A correction to 2-standard deviations below the long term moving average (which is most common within a mean reversion process) would slap investors with 33% loss.

If you don't think a 33% loss is possible you should be aware that that is about the average draw down of the markets during a normal recessionary cycle.  Not only is such an event possible - it is probable when, not if, the economy slips into an eventual recession. 

IMPORTANT:  We are currently invested in the market and I am not suggesting that you sell everything and move to cash.  What I am saying is that the market is very extended and the risk of a correction of some magnitude has increased significantly this year.   Therefore, if you are close to retirement, or simply just can't afford the risk of a major market correction, then you may want to start reducing some of your portfolio risk and begin to build in some hedges against an unexpected event.  Whatever eventually trips up the market will be "unexpected."

Currently, it seems that most of the world's concerns have been put behind us due to the massive injections of liquidity being injected by the Federal Reserve, BOJ, ECB and China.  The Eurozone crisis has disappeared, recessions in the Eurozone and weak US economic data are of little concern, declining revenue and earnings are readily dismissed as the primary driving force for investors is Fed interventions.  However, it is within this complacency, that an unexpected turn of events can pull the rug from beneath the markets and send money racing for the sidelines.  Unfortunately, for most individuals, by the time they realize what is happening it will likely be far too late to act.


Some additional color from Lance on the Taper...(via Bloomberg)

"If I was Ben Bernanke, there would be two things I've got to be concerned about," Roberts said in phone interview today "One is creating asset bubbles: If you look at yields on junk bonds, they are at historic lows. The other is the margin on NYSE stocks, which is the amount of leverage investors have taken on. Markets have gone virtually parabolic"


"What the Fed has got to figure out is if it's solely because of what it is doing or because of the economy and underlying fundamentals"


"At the next meeting, I would start to put out language that says, 'At some point in the future we're going to see some tapering,' and see how the market reacts. If the market reaction is fine, I would start doing that behind the scenes and announce it later"


"It's very possible we'll see hints come before the next meeting. It wouldn't surprise me to see more articles and more Fed officials talking about Fed tapering before June so there won't be a shock to markets"


"If you look at financial markets, they are extremely susceptible to a sharp, rapid correction. It would kill everything the Fed has put together. Bernanke will condition markets long before he takes action. We may see tapering occur prior to the Sept. meeting"


"I'm predicting nothing specific in the next few months. But in Sept., around the Fed's Jackson Hole event, we could get specific numbers"


Roberts said he expects Fed to announce in Sept. tapering of QE to ~$65b/mo. from $85b/mo., with $10b taken off MBS and Treasuries each, followed by another similar reduction later.


"Here's the problem. Some of the economic data is not improving. If you taper off now and we don't have economic strength, the economy is likely to start to slip into a recession quickly. There are also questions of whether the Fed has reached the limit of its abilities to purchase bonds, and why the boost to asset prices hasn't translated into the real economy. Clearly, there's a broken transmission system."

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redpill's picture

Everyone can yammer about it all they want.  The real question is, who has the balls to short it?

Buckaroo Banzai's picture

While the market is clearly overbought, I don't see a negative divergence on the chart. My guess is we will see a very minor correction, then a blowoff top that will generate the negative divergence necessary to sink this pig a la the 2008 crash. In 2007 it took 12 months to generate the necessary negative divergence, so this pig looks like it could have wings into 2014.

TuesdayBen's picture

What does an S&P500 aggregate P/E ratio of 19 today suggest?

Rusticus's picture


A chart of historic S&P P/E ratios is akin to looking at one of transatlantic crossing times in the years that sail was replaced by steam.

Mark to market vs fantasy.

tango's picture

Actually, I can see a LONG rally based on two factors:  The lower deficit and energy.  Forget the bond market - it can be artificially propped for years.  Forget sovereign debt - the subject is no longer in vogue since all attention is turning to stimulus vs "austerity".  The market rises on bad news (FED will pump) or good news (great times ahead).  Of course it's absurd but it works (for a while).

Umh's picture

That's the clue "Clearly, there's a broken transmission system." the bad news string must be touching the good news string.

W T F II's picture

didn't you see my t-shirt...

"Got VIX..?"

LostPolarBear's picture

Every time I try to short it, I get my balls blown off.



Frastric's picture

S&P 1666.66, then short this motherfucking wreck of a casino.


ApollyonDestroy's picture

Oh that would be precious, if only we could get that lucky

MeelionDollerBogus's picture

A grand plan indeed unless the market tops a little more like 1770 say... end of this year? I guess as long as you can cover your maintenance margin requirement...

Chief Falling Knife's picture

Same here.   Now I just stare at the charts everyday in awe.  I can't bring myself to go long.  Buying into the 'new normal' centrally planned world that defies all logic, doesn't sit well with my sensibilities.  Seems to me its inevitable something will break, but until then, I'm just an observer.

MeelionDollerBogus's picture

is it really so hard to use SPY puts? IS it? Can you believe SPY at 180 within 90 days? 60? Can you believe SPY at 100 or even 80 by the end of 2014? I can believe both from the math I’ve done and I will place my very low risk unmargined put & call buys appropriately. Is it really that hard?

Maybe you think it's smart to use that margin and use tight stops but I think it's smarter to use no margin, know precisely the loss of the contract price equals my real equivalent stop (can't lose more than the total) and from there it's all gains... or minimal risk per contract. Think about it.

What price do you think will happen, what would your exit strategy be? I will pull in profits at different levels of sub 150 on SPY, sub 140 and sub 130, so we'll see. Or if they all expire I'll lose cash I could afford to lose, same as if I had a tight stop that got triggered. But no margin and no slippage on the timing / execution of the stop.

MeelionDollerBogus's picture

then stop using margin and actual shorting – start using PUTS and get good with math to pick some dates combined with prices. This “technical” analysis Fibonacci & Bollinger-band nonsense flat out will not cut it. Ever.

tarsubil's picture

Who has the balls to make a single bet in a fixed game of roulette? It's not a matter of balls; it's a matter of knowing the fix or being a moron.

MeelionDollerBogus's picture

if you’re using Puts without margin & good with choosing dates the task isn’t nearly as risky as it sounds. I’m in.

Son of Loki's picture

...and in other Breaking Headline [Sheeple] News....


JAPANESE star chef Miki Nozawa was killed on the German holiday island of Sylt following an alleged dispute with two disgruntled guests about a dish of fried noodles.

The 57-year-old died on Monday as a result of his injuries in the intensive care unit of a local hospital, said Ulrike Stahlmann-Liebelt, the senior public prosecutor from the nearby town of Flensburg.

The results of the autopsy establishing the cause of death were not yet available, Stahlmann-Liebelt said Tuesday.

Two suspects aged 36 and 50, reportedly skilled workers, are still at large.

Local media reports say the dispute centred on a dish of fried noodles with vegetables and beef.

Read more: Wow, life is so....unpredictable......
max2205's picture has to go down to give a sell sig....hows that working for you/us

Frank N. Beans's picture

<redacted> Bernanke!!

Sudden Debt's picture


the markets know more than we do...
thus... we're all idiots...

cloudybrain's picture

it will keep climbing printing press still running..

gjp's picture

yeah what's to stop it?  Zimbabwe kept rising and so did the WeimarDAQ.  The whole stock market might not have bought a banana across the border but it was up up and away in its domestic currency.

MeelionDollerBogus's picture

I believe the “technical” term for this chart formation is the “wall-of-what-me-worry?”

madbraz's picture

Such deep analysis to conclude that he is still "invested in the market" is the symptom of the idiocy that prevails in these circles.

ghostfaceinvestah's picture

If the music is still playing...

buzzsaw99's picture

I personally am waiting for S&P 1743 to go all in.

Shizzmoney's picture


Here's the problem. Some of the economic data is not improving. If you taper off now and we don't have economic strength, the economy is likely to start to slip into a recession quickly. There are also questions of whether the Fed has reached the limit of its abilities to purchase bonds, and why the boost to asset prices hasn't translated into the real economy. Clearly, there's a broken transmission system."

They will never stop printing.  They can't. 

Think of the scene where Tony Montana is in his office in his multi-million dollar mansion, blood, cocaine, and bullet holes everywhere.......a rags-to-riches dream that is coming to its envitable conclusion....back to he takes his AK-47 and introduces his rivals to his little friend as they finish the law of matter's job.

Now think of the Fed as Montana, and Benny Boy instead of an AK-47, he has a money printer.

In a sense, the story of the United States and the story of Tony Montana have many paralells.

And like, "scarface", this shit will end badly.


TrumpXVI's picture

Tony Montana's "Little Friend" was an M4/M16 variant, not an AK.

ParkAveFlasher's picture

Blythe Masters as Michelle Pfeiffer? {{{shivers}}}

andrewp111's picture

Like I said before, pedal to the metal until the engine blows a rod.

buzzsaw99's picture

Cheering for more market manipulation are we?

Sudden Debt's picture

money problem no is , printing we just do.

Sudden Debt's picture




Sudden Debt's picture


Meaning we could still rally 20000 points on the dow....

bdub2's picture

S&P Crash -.87!!! I'm all in. Best buying opp in this or any other lifetime! Thank you dead economy!!! Sucka'z...sarc

Incidentally, lowest retail investment participation rate since 1998. Market rallied another year year and a half to blow off top...getting out in 98 big mistake. 

I will continue to invest in the S&P CD 500, forever.

RSloane's picture

The economy is likely to slip into a recession quickly? Really? Half the God damn country is on some type of assistance program. One in five families is on food stamps. There has been an increase of 400% on the disability rolls to play the ever popular shell game of costs and expenditures. Show me the transmission mechanism whereby anything the mulitple QEs and the sons of QEs has improved the lives of the people on main street.

The Fed and their devotees can take their fucking hints and shove them up their asses sideways.

Dr. Engali's picture

I'm not quite sure I get your point. Care to elaborate a bit? :)

I watched some interesting YouTube videos touring Detroit yesterday. It's pretty incredible to think that is was one of our most prosperous cities, and now it's a decimated hell hole.

RSloane's picture

The author is just another gas bag who does not want any tapering of any kind because it might lead to a recession. My point is what the hell does he call what we have now? A pre-recession? A bump in the road? An economic oopsie? Sorry, I get so angry sometimes Doc. He has to be some kind of fucking idiot to anxiously await some kind of 'telegraphing' from the Fed when all he has to do is stick his head out the window and observe people on main street and under what conditions they are living. To me he's just another QE ad infinitum idiot.

I need a drink.

Palladin's picture

I watched some of them too, and it was pretty depressing. Just for the fun of it, I put the street that the guy said he was driving down into Google Maps and switched to the Street View. It didn't look anything like the YouTube video.

The only thing I can't say for sure is what the date was when the Google Map pictures were taken. It could have been many years ago, it could have been yesterday. And I might have been way off in the addresses.

FWIW, Zillow shows all the houses on that street in the $35,000-$45,000 range, so they can't be in all that great of shape.

Maybe the Google Maps street view shows the neighborhood as it once was, and the YouTube videos show it as it is today.




MeelionDollerBogus's picture

Yup… now think of the places that were already hell-holes and had no reason to improve… oh man.

mayhem_korner's picture



Overly simplistic analysis.  The context of standard deviations becomes much less relevant when the underlying environment is in flux.  The $85B per month of rent-seeking liquidity that has been levitating the market for the past 6 months mutes the stats. 

Until the punchbowl is pulled away, or enough critical mass calls the bluff of the printed bux, the market actually can continue to rise.  I view the S&P as an index of how in-the-dark people are - and it's already gone much higher than I thought it would.

madbraz's picture

It's not over simplistic, it's factual.  If you make 50% in 6 months or less, odds are you are going to sell instead of risking much for little more.


When the stock market goes 100 days without a 3 day correction for this first time in over 120 years of data, it is factual.  You can bet that the elastic band can be stretched even further, but the odds of it snapping increase exponentially.

mayhem_korner's picture

When the stock market goes 100 days without a 3 day correction for this first time in over 120 years of data... means that either you have a non-stationary distribution or your measurement is biased.  I gather you did not pass statistics, but thanks for making my point.

MeelionDollerBogus's picture

it’s overly simplistic because the connected series of prices do not, as presented, lead to any useful predicted future pattern, as asserted.

Professorlocknload's picture

What would be the "long term" SD's on this chart, say from the peak in 1946 to the peak in 1966?

Then, from the peak in 1981 to the top in 2000? (Extrapolate the two 20 year periods mentioned above, out to 2020, and ponder the possibilities of Dow 30,000. Or Dow Zero, if this is the Crackup Boom and it reaches it's "mean" conclusion.


Yeah, unlimited injections of free money would need to be considered/compensated for to make statistics conform to any potential biases, but there is a precedent or two here.

Like the biggest bust since the "Big One," all but guaranteeing the biggest money creation binge in history. We're in it ass deep to a tall Swede.


Professorlocknload's picture

Addendum; What are the Standard Deviation calcs on an Algo trading program gone wild?


Who Laughed's picture

he who dances down the primrose path

must also die on the primrose path

malek's picture

 One standard deviation from the mean (average) encompasses 68.2% of potential outcomes [...]

Unfortunately that is only true if you have a Gaussian distribution (Bell curve), which is a deeply flawed assumption for capital markets in the first place.