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How Big Would A 'Real Correction' Likely Be?
Submited by Lance Roberts of STA Wealth Management,
Over the last few days, my inbox has been overflowing with emails all asking the same question: "Is this THE correction?"
The actual answer is probably "NO" for a couple of very specific reasons. First, even though the Federal Reserve is tapering their purchases, they are still currently injecting $25 billion per month which flows directly into the financial markets. (For more on this issue read "Misunderstandings On The End Of QE")
Secondly, full-fledged bear markets rarely happen when everyone is o the lookout for one. For example, here are just a few of the news articles over the last two days relating to this topic:
- How You Will Know If It's Time For A Market Crash?
- Warning: The Stock Correction Is Just Beginning
- A Pullback Or The Beginning Of A Bear Market?
- Is It Time To Panic Yet?
You get the idea. Regardless of whether you lean more towards the "bullish" or "bearish" persuasions there has been more than enough commentary as of late to satisfy both. Major market corrections tend to occur when they are least expected and are propelled by an unforeseen event that "panics" investors.
However, there is still a good question to be answered here.
"If this is the beginning of a more important, intermediate term, correction; how large could it be?"
As a portfolio strategist, this is the right question to ask. Why? My portfolio allocation models remain near fully invested. (I have been recommending in the weekly newsletter over the past several weeks to rebalance portfolios, to reduce risk, by trimming winners and selling laggards. These actions have raised cash levels as of late.) Therefore, what concerns me most is NOT what could cause the markets rise, as I am already invested, but what could lead to a sharp decline that would negatively impact investment capital.
[Important Note: It is worth remembering that winning the long-term investment game has more to do with avoidance of losses than the capturing of gains. It is a function of math.]
There is not just ONE answer to the question posed above. There are many factors that can, and will, contribute to the eventual correction. I am also not suggesting that an intermediate term correction has started, NOR am I predicting the timing of one. What I do want to explore with you today is the potential magnitude of a correction so that we can better understand the consequences to our portfolios of being misallocated at the turning point. (The following analysis is designed for a longer term perspective to identify risk/reward and potential changes in underlying trends.)
The first chart is a simple trend-line analysis of the weekly S&P 500 index.
As shown, the bull market trend that begin in 2009 remains currently intact (dashed blue line). A correction from current levels back to that bullish uptrend line, which occurred in both 2011 and 2012, would entail a decline to 1700. That would be a 14.6% decline from the recent intra-week market peak. While not technically a "bear" market, for many investors it will certainly "feel" like one.
However, in December of 2012, Ben Bernanke launched the latest round of monetary stimulus at a whopping $85 billion dollars a month. At that point, the markets elevated away from the previous bullish trend to establish a new trend (black dashed line). At the current time the intersection of that elevated bullish trend, which has repeatedly acted as support for the markets since the end of 2012, is at 1900. There is also some more minor support just below at 1850.
Currently, there seems to be nothing on the horizon to intensify the current "pullback" into a selling "panic." Geopolitical events, weak underlying economic data, and extremely stretched market valuations have posed no immediate threat to the markets. This is clearly shown in the 6-month average of the Volatility (VIX) Index (a 6-month average is used to smooth the volatility of the volatility index.)
The 6-month average of the VIX is currently at the lowest levels of this century. Understand that it is NOT the decline in the VIX that is important, but rather the point at which the 6-month average turns higher. If you look at the chart you will see that 6-month average of the VIX turned, and begin to trend higher, just prior to the peaks of the market in 2000 and 2007. The same occurred in 2011 and 2012. Currently, the 6-month average of the VIX is still trending lower which suggests that the current correction, at this point, is just a pullback within the current uptrend. However, as you can see above, that can change very rapidly.
Should volatility begin to accelerate, this would be coincident with a much larger correction that would bring into focus the 2009 bullish trend line, as shown in the chart above. However, another way to look at potential corrections is to use a "Fibonacci Retracement" analysis as shown in the chart below. As defined by Investopedia:
"The Fibonacci retracement is the potential retracement of a financial asset's original move in price. Fibonacci retracements use horizontal lines to indicate areas of support or resistance at the key Fibonacci levels before it continues in the original direction. These levels are created by drawing a trendline between two extreme points and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%."
As identified in the chart, the 23.6% retracement level basically confirms the 2009 bullish uptrend line around 1700 currently. If the market begins a more serious correction, this level should provide support for a short-term bounce that should be used to "sell" into to decrease equity risk in portfolios. The bounce from this support will most likely fail in short order. The markets will then either:
a) retest support at the bullish uptrend/23.6 retracement level and turn higher allowing equity risk to be increased, or;
b) that support will be violated, and the market will likely seek out the 38.2% retracement level at 1490.50. Such a decline would increase the magnitude of the correction to 25.14%. This would officially push the markets into "official" bear market territory.
While it is entirely possible, it is unlikely that (b) will happen outside of the onset of a recession. When the eventual "recession" does return to the economy, it is very likely that the markets could test the lower Fibonacci bands of 50% and 61.8% retracement levels.
The next chart is a "relative strength" and a "2-standard deviation" analysis of the weekly chart of the S&P 500. First, in the chart below, it is unusual for the markets to consistently push 2-standard deviations above the 50-week moving average for such a long period without a correction back to it. A correction back to the 50-week moving average at this point would entail a decline to 1829.31, a 8.12% decline from the recent peak.
Importantly, a decline to 2-standard deviations below the 50-week moving average would converge at the 1700 level, which as discussed above, is also home to the 2009 bullish trend line and the 23.6% retracement level.
The lower part of the chart is the "relative strength" index (RSI). This index has turned lower as of late with the recent correction and is currently posted a reading of 60. Levels of 80 represent "overbought" markets and levels below 40 represent periods of being "oversold."
I have notated (vertical red lines) points at which the RSI had peaked and turned lower. Historically, the RSI tends to oscillate between 80 and 40 on the index. However, since the beginning of the latest round of Quantitative Easing (QE) by the Federal Reserve, the range has remained between 80 and 60. The same anomaly is shown in the next chart which is an analysis of the market relative to the Williams %R indicator.
The Williams %R indicator, like RSI is a representative of "overbought/oversold" conditions in the market by measuring changes in the momentum of prices over a specific period of time. From the beginning of 2009 to the end of 2012 (highlighted in gold), the index oscillated between levels of -20 or less, "overbought," to -80 or greater, "oversold." However, beginning in 2013 the oscillation has remained tightly constrained between ZERO and -30. This is unsustainable longer term and a break below the -30 level on the Williams %R will likely indicate a more severe deterioration in the markets.
There is no exact answer to the potential magnitude of a correction in the markets. "This" depends on "that" to occur which is why trying predict markets more than a couple of days into the future is nothing more than a "wild ass guess" at best. However, from this analysis, as shown in the table below, we can make some reasonable assumptions about potential outcomes.
Currently, there is a convergence of points between 1650 and 1700 on the index that will present rather important levels of support for the market currently. Not only would a correction to such levels be a "healthy" event in order for the current "bull market" cycle to continue, it would also likely present a fairly decent opportunity to increase equity exposure in portfolios. As I noted above, a correction of 14-16% is far outside of the expectations of the market currently. Such an event will likely "feel" much worse to individuals that have inadvertently taken on excessive risk in their portfolios by "chasing" markets and "yield."
However, while I show that the greater levels of a potential correction will likely be coincident with a recession, as they have historically been, it does NOT mean that a recession is required. A sharp rise in interest rates or inflation, a downturn in economic growth, deflationary pressures from the Eurozone, or a credit related issue in the "junk bond" market could all do the trick.
No one will know, until in hindsight, what the catalyst will be that ignites a "panic" in the market. This is why we do analysis to understand the potential risks in the market as compared to expected reward. What is abundantly clear is that the potential "upside" in the market is currently outweighed by the "downside" risk. It is important to remember that our job as investors is to "sell high" and "buy low." Unfortunately, for most, it is exactly the opposite.
There is one important truth that is indisputable, irrefutable, and absolutely undeniable: "mean reversions" are the only constant in the financial markets over time. The problem is that the next "mean reverting" event will remove most, if not all, of the gains investors have made over the last five years. Hopefully, this won't be you.
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What is this "market" you speak of?
Your avatar is my favorite...her ass is amazing. Sorry. Sidebar.
But it doesn't deliver on his name. I am disappoint.
When it goes bidless the "market" will have corrected itself.
I'd say 50% is a "Real Correction"....We should be nowhere near where we are....
I'd say a real correction would be the day the markets don't open. Anything else is centrally planned.
Im thinking on a monday, after a banking holiday is declared on a friday afternoon?
On a Friday evening. Never in the afternoon.
100% Fib retrace takes us back to 666.
HOLY SHIT REALLY? and a few weeks ago christine lagarde said a bunch of shit with 7s in it too!!!!! 666 and a bunch of 7s and a bunch of other occult shit is going down. ITS THE DEVIL.
I really wouldn't read that far into any of this shit. Its a bunch of liars and morons trying desperatly to keep their worldwide ponzi scheme alive as long as possible so they can leech a little more wealth off the populace by keping them stupid. Its as simpe as that
"As long as the shells are still being shuffled around people can be deluded into believing there is something worthwhile under one of them"
Anonymous 2014
oh i meant after close of business for banks and markets kind of afternoon, not afternoon as in right after lunch or something like that.
Exactly! This market is just as full of shit as it was a week ago. And until they can get Putan to strike or get into Syria and get a jihad going in America they will run up as much debt as they have to. The US debt clock is up 60 billion this week 1trillion in 10 months but nobody says shit. So nothing to see here move along
Any illusions about whether or not that debt will ever be paid off can be dispersed here and now, because the way the system is designed total debt can only go up. In fact, there is not enough money in existence to pay off that debt even if everyone in world decided to go all in on it right now.
you idiots keep screaming correction correction, and then money printing inflation inflation...guess what you dummies, in inflation markets inflate along with everything else.
I say 70% would bring as to the real value
If one were to be grading this market, it would be getting a A- for D+ fundamentals.
A real correction would be banksters falling from the sky.
Sometimes we get "unintended consequences" like what you speak of....
In a just world, those consquences would definitely be intended.
Banksternado over Hawaii??!!!!
Wells work too.
We've actually seen a bit of that recently. Stay positive. A downpour usually starts with a trickle.
...assuming that this market allowed for true price discovery of course.
No matter how big the correction, Yellen can print more than that.
BTFD, or you are an unpatriotic American unlike Warren Buffet or Bill Gates or Jamie Dimon.
It needs to be a confidence crushing event that you wake up to, futures limit down 10% and then have it go thru the 20% and 30% suspension cycles until a significant number of people driving Teslas start ramming them into bridge abutments to avoid having to face the music.
That's my happy place, what's your's?
mine is that when what you describe comes to pass, people direct their anger where it should be. I'm not saying wall street is innocent(I believe most of them are criminals), I'm not defending what they have done at all, but none of this would have been possible without the federal reserve and the government. I just hope this next crash wakes people up to reality, and these institutions get their due
With leverage averaging around 30% market wide in order to chase some yield, it only takes a 4% 'correction' to completely lose everything, and ram their Teslas into bridge abutments in order to avoid facing the margin call.
My mom and older brother moved their money to more conservative positions about six months ago. I keep telling them in is in, if they really want safety they need to cash out and get physical assets.
They mumble about tax issues and wander off... I hope they chose their positions well!
We must break 666.
Big? Just sayin.
Dow 3000
Gold 10000
Silver 1800
Copper 35.00
Ect
what you say would require people to run out of stocks and pile into gold and silver. They won't. Ever. Too conditioned against it. They may sit on the sidelines for a while as stocks go down the shitter again, but once they start printing again, stocks will go up alongside gold and silver. The difference is those stocks will be priced in increasingly worthless dollars, and the markets won't rise as fast as the dollar value falls. Gold and silver, on the other hand, will just be gold and silver, and you probably won't care what the dollar price for either is, since you aren't going to be willing to give any up in exchange for dollars, and neither will anyone else
Soon or later the printing press will run out of ink
Those that think its going to go on forever will be fukd
Yellen's printers don't need ink.
After more than two years of patience I'm still sticking to my guns with the next big moves being flights to safety, involving sliding equities and a rush into bonds first, followed by a most tragic unwinding of the bond bubble and then rocketing commodity (including PM) prices as political isolationism of the US and many other nations takes hold.
It is time for me to bump up my silver stash. Before, I've always done face to face cash transactions at a dealer in Burbank. Do you guys prefer that method, or is online a safe way to go? And if so, what sites have been stellar in their behavior?
ive bought from apmex and silvertowne, had nothing but good experiences with both. If you just want generic bars or rounds for the cheapest possible price, go to silvertowne and order one of the several unique bars they make typically come with free shipping and are cheaper than ive seen anywhere else. Apmex will sometimes beat them in price, but only if you are ordering a lot(several thousand $ worth) at a time. That said, ive found a good local place who i now give the majority of my business. Its a little higher of a premium, but I prefer cash and carry, face to face business transactions.
JM Bullion has free shipping on all orders, which is rather nice if you're not placing a single large order or want to just buy something small to give them a try.
http://www.jmbullion.com/silver/
And since silver is the best conductor known there are simple tests to ensure you are getting the real thing.
http://www.youtube.com/watch?v=WaYh3SlRK0w
How many angels can dance on the head of a pin?
focus on tomorrow and next week.
focusing on what will happen in 6 months can be detrimental to your trading health
Mean reversions yes, but with QE the mean keeps moving up while you're not looking.
"full-fledged bear markets rarely happen when everyone is on the lookout for one"
Myopic... everyone has no clue. Ask your landscaper, garbage man, teachers, carpenter, home depot employee, waiter, dental hygenist... you'll find very few that know or care about the stock market.
We on ZH are tuned-in because we, I suspect, have some skin in this bullshit GAME. I know my friends and family are simply working. They really don't have time nor give a crap. They watch sports more than stocks.
Everyone doesn't know... rather, the few with some savings... only occasional learn (every 5 years or so) from their broker that they will never have enough to retire.
Thats everyone
I'd say a 50% rally from current levels wud be a good korrecshun!
"Real Correction" file under "Real Bookkeeping", "Real Transparency" or even under "Real Truth"...ha-fuckin' ha!
What does Auntie Yellen say?
I like my Monthly chart better than Tylers because it just called a top.
http://tinyurl.com/mbroor3
OT but the ten year is getting kicked in the crotch, anyone still believe we will turn out much differently than Japan if we survive a few more years??
..there simply is no bridge back, it got burned.
All that's left is to ride this puppy into the ground and then start the finger pointing towards someone totally innocent if history is consistent.
Yes, the entire system has to change, and America will be very very lucky if it can elect the people who will make the necessary changes without assuming dictatorial type power over the populace.
the trendline above was created by linear scale.....iw we use logaritmic scale, SP500 pass by 1.800.....
1.800 is my first target to this correction........
You'll never know because the FED is using software to control the markets since December 2011.
The Fed has access to unlimited funds and seems to be active in supporting the appearances of stability.
Are you postulating that the Fed is tired of having the numbers look good? Because as far as I can see (and read) it is the Fed and not the underlying economy that keeps the numbers where they are.
..are you telling me this market is not driven by legitimate price discovery?
I think their main concern is now making a smooth egress and shifting ultimate liability without tipping the hand, and that is going to be a real trick today.. giving it a twenty percent haircut to convince the last to get back on board without the bottom falling out just might backfire because there are a lot of itchy triggers not wanting to be the staked goat.
It's gonna be epic
http://newamerica-now.blogspot.com/2014/02/beyond-collapse.html