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How Far Will the Stock Market Rebound Go?

Tyler Durden's picture




 

Submitted by Pater Tenebrarum of Acting-Man blog,

A Brief Look at the Technical Backdrop

We can actually not answer the question posed above with certainty. We don’t know for sure whether the recent market decline was a “warning shot” or merely a short term shake-out. In this we are in good company: the whole world doesn’t know.

However, our guess at this juncture is that the decline was of the “warning shot” variety, as it has violated long-standing uptrend support lines – something that the market has managed to avoid in previous corrections over the past three years. There are also fundamental reasons for thinking so, which we discuss briefly further below. However, based on fundamentals alone, it cannot be determined whether the stock market is already “ripe” for a larger degree decline, or whether its uptrend will resume in the short/medium term.

To be sure, the technical picture certainly conveys no certainties about the future either. However, should the market peak at a “typical” retracement level or at a previous lateral support level (thereby confirming its new status as resistance) and resume its decline from a lower high, yet another change in character will be recorded. In that case, the probability that a larger degree decline is underway would accordingly increase further.

Below are charts of the most important indexes showing Fibonacci retracement levels of the recent correction and lateral resistance levels. Although it is unknowable why the market often finds support or runs into resistance at Fibonacci retracement levels (there is certainly no logical reason for this), it has happened quite often in the past, so it is useful to be aware of them. Possibly it has become a self-fulfilling prophecy, because so many traders use technical analysis nowadays.

The first chart shows the S&P 500 Index (SPX), the NYSE Composite (NYA), the Russell 2000 (RUT) and the RUT-SPX ratio. What is noteworthy is that the Russell outperformed the large cap indexes from Monday to Thursday, thereby giving slight advance warning of an imminent short term low. However, this streak ended on Friday. Whether that was just a short term blip remains to be seen, but one should continue to keep an eye on the Russell’s relative performance. If the action on Friday was the start of another period of underperformance, it will represent a fresh warning signal. Note that large speculators have amassed a fairly large short position in Russell 2000 futures. In the short term, this may invite some additional short covering. However, speculators have largely been correct with their bets on Russell futures over the past decade (apart from a brief moment in the summer 2011 correction).

 

1-SPX, NYA and RUT

SPX, NYA, RUT and RUT-SPX ratio. Fibonacci retracement levels and nearby lateral resistance levels – click to enlarge.

 

The next chart repeats the above exercise for DJIA, Nasdaq and NDX.

 

2-DJIA, COMP and NDX

DJIA, Nasdaq and NDX. All the major indexes have essentially bounced back to the 38% retracement level that is generally regarded as the minimum target for a rebound. 50% and 62% rebounds tend to be more common per experience, but there can be no assurance that either of them will be reached – click to enlarge.

 

Sentiment Data

Below are charts of a few sentiment data, mainly short term oriented ones (long term sentiment indicators are still at levels that are among the most extreme on record – specifically, mutual fund cash levels remain close to a record low, while margin debt is still close to a record high). The first three indicators are the equity only put-call ratio, the Rydex bull-bear ratio and Rydex bear assets:

 

3-CPCE and Rydex
The equity put-call ratio is in “signal-less” territory at the moment, but the Rydex bull-bear ratio is close to its year-to-date low, while bear assets are close to a year-to-date high. However, they remain at levels that have either only been recorded in 2014 and 2000 (bull-bear ratio) or solely this year (bear assets remain in a range that is the smallest in history) – click to enlarge.

 

Next we take a look at the Investor’s Intelligence survey. The percentage of bulls in this survey (which was taken on Wednesday, when the market reached its intra-week low) has not surprisingly declined quite a bit, but has happened with the bear percentage is quite remarkable. Just as Rydex bear assets remain within their lowest range on record, the bear percentage in the II poll has risen to a mere 17.3% – which used to be considered extremely low in the past.

 

4-II-Poll

The Investor’s Intelligence Poll. Why is the percentage of bears still so tiny? – click to enlarge.

 

The reason why we are bringing this up is that there has never been an important correction low with the bear percentage in the II-poll at a mere 17.3%. Normally we see it swell to between 40%-50% (see 2011) at major correction lows and it tends to at least approach 30% in minor corrections (see 2012). 17.3% is normally consistent with a market peak rather than a low.

What this and the extremely low level of bear assets in the Rydex funds is telling us is that practically no-one expects a big decline. Many investors and investment advisors seem to be allowing for a correction, and may even concede that it could become larger, but very few seem to be concerned about the potential for a really big downturn. This is a negative contrary indicator for the market.

 

Fundamental Backdrop

It is clear by now that the economies of the world ex the US aren’t performing particularly well. China’s economy is slowing noticeably after money supply growth fell to its lowest rate of change in many years, which has impaired the country’s real estate bubble. Since China’s authorities seem to be set on continuing to move the economy away from overbuilding and massive capital investment, no significant monetary stimulus measures should be expected in the near future.

What strikes us as remarkable about the situation in Europe is that all it took for the ongoing economic malaise to become a “triple dip” recession, was a slowdown in true money supply growth from a peak of 8.6% to a recent 6% year-on-year. This is noteworthy, because it is the first empirical confirmation of our long-held suspicion that the “threshold level” at which a slowdown in money supply growth unmasks various bubble activities in the economy has increased.

We suspect that something similar may apply to the US economy. While the broad US money supply TMS-2 most recently still grew at a historically high rate of approx. 7.6% y/y, this represents a massive slowdown from the approx. 16.5% to 17% peak levels of late 2009 and late 2011. At the same time, the economy remains quite imbalanced. The ratio of capital to consumer goods production has continued to climb and is currently just down a smidgen from a recent new all time high. If one compares capital and consumer goods production side-by-side, there is now an unprecedented gap between the two. We believe this is a result of the artificial suppression of interest rates by monetary pumping. Note in this context also that the huge issuance volumes in the junk bond market in recent years are by themselves already indicating that a lot of malinvestment is in train. These economic activities would under normal circumstance never get this much cheap funding. We can be quite certain that a lot of the associated investments will eventually turn out to have been misguided.

 

5-Capital-Consumer-Goods-Ratio

The ratio of capital goods (business equipment) to consumer goods production in the US has reached a new all time high recently – click to enlarge.

 

6-Capital, consumer, cons-nondur

Only two times in history has capital goods production in the US exceeded consumer goods production (the red line shows consumer non-durables production, which has barely increased since the 2008 crisis) – click to enlarge.

 

Such economic statistics must of course always be taken with a grain of salt; for instance, monetary inflation is certainly not the only factor in the rising long term trend of US capital goods production exceeding consumer goods production. Partly it can be explained by the fact that a lot of consumer goods production has moved off-shore. Even so, there are still discernible fluctuations, which are mainly the result of boom-bust cycles induced by monetary pumping.

When interest rates are artificially suppressed by large additions to the money supply, more and more investment tends to move toward production processes temporally distant from the consumer stage. This is because under conditions of monetary pumping, price signals in the economy are falsified. Longer production processes that would normally be avoided because they are not in line with society-wide time preferences suddenly appear to be profitable, and it is only later revealed that either the real resources to complete them are lacking, or if they are completed, that they simply cannot be continued without incurring major losses once the price structure has normalized.

Usually this normalization in relative prices occurs once monetary policy becomes tighter – and this is indeed happening now (“tapering” of QE is tightening, even if the Federal Funds rate remains at rock bottom levels).

Lastly, given how poor the economic recovery has been overall, we can tentatively conclude that the economy’s pool of real funding has sustained severe damage in the preceding credit boom(s), and has undoubtedly been weakened further in the most recent one.

For the stock market (and other “risk asset” markets like junk bonds and also higher rated corporate bonds) this means that the fundamental backdrop that makes a major denouement possible is definitely in place now. However, we cannot state with certainty whether there is still room for the imbalances to grow even further. What we do know for sure is that the risks appear very high already.

 

Conclusion:

In the past few years the stock market has always recovered from corrections to make new highs, and we cannot be sure if the party is indeed over. However, both from a fundamental and technical perspective, the probability that it is over seems quite high. Should market internals and trend uniformity to the upside improve again, this assessment would obviously have to be revised. However, there are surely more than enough warning signs extant now and every financial asset bubble must end at some point.

As an aside, in spite of the heavy cooing by various Fed doves last week, we don’t think the present course toward tighter policy will be abandoned immediately. For the Fed to actually react, a lot more damage would likely have to occur in asset markets and economic data would have to become uniformly negative, which is so far not the case in the US. The danger that it will happen – i.e., that similar to Europe, the slowdown in money supply growth will render numerous bubble activities unprofitable – is however great.

 

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Mon, 10/20/2014 - 08:25 | 5354575 LoneStarHog
LoneStarHog's picture

The party in real as opposed to nominal ended years ago...The only thing left are the damn drunks who refuse to go home.

Mon, 10/20/2014 - 08:32 | 5354584 Cognitive Dissonance
Cognitive Dissonance's picture

Now that the psychological punchbowl has been withdrawn a lot of drunks are suddenly sober. Long asprin.

Mon, 10/20/2014 - 08:40 | 5354598 GetZeeGold
GetZeeGold's picture

 

 

What was that famous statement about the Titanic again?

Mon, 10/20/2014 - 08:45 | 5354618 AdvancingTime
AdvancingTime's picture

Good one!

Even God couldn't sink this ship.   

Yellen should take notice!

Mon, 10/20/2014 - 08:57 | 5354645 RaceToTheBottom
RaceToTheBottom's picture

If one is so enamored with technical levels why not use the technical level when all the printing money started?

Mon, 10/20/2014 - 09:12 | 5354703 eclectic syncretist
eclectic syncretist's picture

The consumer technology revolution that began in the 1990's is coming to an end.  One of the most obvious signs is that Apple is now making its smartphones LARGER, when for decades a fashion and convenience premium was being paid for electronics that were SMALLER.  Now they are out of innovations and are basically trying to convince people that the model they sold you 5-10 years ago is better than the one they're selling you now.

Mon, 10/20/2014 - 09:04 | 5354662 SunRise
SunRise's picture

God didn't have to.  Human arrogance did it by believing that human achievement bounded within the sphere of Nature magically escaped to rule it.

Mon, 10/20/2014 - 08:28 | 5354576 Leonardo Fibonacci2
Leonardo Fibonacci2's picture

Help!!!

 

 

signed, "the clipboard guy"

Mon, 10/20/2014 - 08:56 | 5354606 GetZeeGold
GetZeeGold's picture

 

 

18 days left to go before the all clear Clipboard Guy......good luck!

 

If you're feeling sweaty......contact Flounder.

Mon, 10/20/2014 - 09:48 | 5354814 indygo55
indygo55's picture

Speaking of the clipboard guy, just who is he? Has anyone identified him? Where is now? Who does he work for? I wonder who he really is.

Mon, 10/20/2014 - 10:03 | 5354850 DeadFred
DeadFred's picture

Didn't I see him at Sandy Hook and at the Boston Marathon? Maybe it was someone else...

Mon, 10/20/2014 - 08:30 | 5354577 firstdivision
firstdivision's picture

As far as the motherfuckin' central banks want it to.  everything is priced in lollers.

Mon, 10/20/2014 - 08:36 | 5354592 LULZBank
Mon, 10/20/2014 - 13:05 | 5355498 reTARD
reTARD's picture

Stawks are like an extremely coiled spring right now. The rebound will be tremendous. We're talking about a rocket to the moon! ;-)

Mon, 10/20/2014 - 08:30 | 5354578 madcows
madcows's picture

Dow 40,000!

Mon, 10/20/2014 - 08:33 | 5354588 tocointhephrase
tocointhephrase's picture

That would be a nice number to trade 1 for 1 with an oz of Au. Or maybe I should wait for 'New Dollars'?

Mon, 10/20/2014 - 08:50 | 5354630 sleigher
Mon, 10/20/2014 - 08:55 | 5354648 madcows
madcows's picture

For the unaware, the Dow 40,000 was a prediction made by Dent back in 2000, right before the dotcom implosion.

 

http://en.wikipedia.org/wiki/Harry_Dent

Mon, 10/20/2014 - 08:30 | 5354579 Sinnedi
Sinnedi's picture

I WANNA SEE IT CRASH! I WANT TO SEE IT CRASH! I'm sick of the suspense it is like trying to have an orgasm when you came 4 times already. Just before you are about to cum the feeling goes back all the way down to your groin.

 

PST on due date of crash anyone

Mon, 10/20/2014 - 08:43 | 5354610 negative rates
negative rates's picture

Sinbad the sailor said it was yesterday, and we trust him.

Mon, 10/20/2014 - 10:06 | 5354861 DeadFred
DeadFred's picture

The 28th. Market is closed the 29th so buy your options accordingly. If the S&P is up more than 0.2% today ignore this prediction.

Mon, 10/20/2014 - 08:32 | 5354585 25or6to4
25or6to4's picture

Markets long ago decoupled from reality. Good luck trying to figure them out via technicals.

Mon, 10/20/2014 - 08:34 | 5354589 Peter Pan
Peter Pan's picture

Since when do fundamentals and technical analysis count?

We live in an age where experimental dialysis is the norm.

You only have to look at the mediocre stirrings of gold to realise that the elite are pulling on the strings harder than ever despite the puppets looking exhausted.

Mon, 10/20/2014 - 08:45 | 5354614 negative rates
negative rates's picture

Since when do the puppets get exhausted? They just bring in new puppets.

Mon, 10/20/2014 - 10:14 | 5354879 El Vaquero
El Vaquero's picture

But the new puppets do their shopping in scooters with their guts hanging down below their crotches.  They're kind of tough to make dance.

Mon, 10/20/2014 - 08:35 | 5354591 BinAround
BinAround's picture

Where is the chart for the worsening interface @ ZeroHedge?  The pop-up boxes and slow-loading text is annoying.  Time to look for a better financial blog! 

Mon, 10/20/2014 - 08:44 | 5354615 GetZeeGold
GetZeeGold's picture

 

 

You're doing it wrong.

Mon, 10/20/2014 - 08:38 | 5354597 Bold Eagle
Bold Eagle's picture

The party is over because winter is almost here. And you know what economy does when it snows.

Mon, 10/20/2014 - 08:42 | 5354605 nightwish
nightwish's picture

Dow belongs at 9999, will hit 19,999 come presidential election time based on Fed finagling and other shenanigans

Mon, 10/20/2014 - 08:44 | 5354613 AdvancingTime
AdvancingTime's picture

 The term "the new normal" has not been used enough as of late, but going forward it may be about to return. Many investors and the public at large may be about to realize that central banks can only do so much through printing money and lowering interest rates. Both these actions carry with them some very strong and nasty side effects. Markets have become very distorted as money has flowed into risky assets in search of higher yields.

It could be we are about to see the markets morph into a "realizing market", one that grinds slowly downward. Another possibility is that at some point the wisdom of buying every pullback changes and the market simply drops like a stone. Tensions are elevated in many parts of the world and we cannot rule out the possibility of a major war. The world is rapidly changing and nobody has a crystal ball that will predict how this will all play out. The article below delves into what to expect as the storm clouds gather on the horizon.

http://brucewilds.blogspot.com/2013/06/realistic-expectations-for-economy.html

Mon, 10/20/2014 - 08:47 | 5354624 gswifty
gswifty's picture

"What strikes us as remarkable about the situation in Europe is that all it took for the ongoing economic malaise to become a “triple dip” recession, was a slowdown in true money supply growth from a peak of 8.6% to a recent 6% year-on-year. This is noteworthy, because it is the first empirical confirmation of our long-held suspicion that the “threshold level” at which a slowdown in money supply growth unmasks various bubble activities in the economy has increased."

This. The titanic is taking on water at an ever-increasing rate. Bail faster!

Mon, 10/20/2014 - 08:55 | 5354644 Latitude25
Latitude25's picture

TA is all bullshit in totally manipulated markets.

Mon, 10/20/2014 - 09:15 | 5354712 eclectic syncretist
eclectic syncretist's picture

There is a possibility it will become more meaningul if and when the Fed is no longer so manipulative and fear and greed again rule the beast.

Mon, 10/20/2014 - 09:31 | 5354770 rejected
rejected's picture

"We don’t know for sure whether the recent market decline was a “warning shot” or merely a short term shake-out. In this we are in good company: the whole world doesn’t know."

Can anyone believe people still 'acting' and "talking" as if this were a true market!

Astonishing.

Mon, 10/20/2014 - 10:15 | 5354880 eddiebe
eddiebe's picture

Seems to me that unless there is a currency crisis the party can go on forever, because the central banks can goose or slam any market at will. There is no stopping them unless or until the tyranny of fiat is exposed and widely understood.

Mon, 10/20/2014 - 10:48 | 5354986 manich
manich's picture

"fundamentals"

LOL! How about fundamentally corrupt/fixed.

Mon, 10/20/2014 - 12:12 | 5355246 lasvegaspersona
lasvegaspersona's picture

The only real question is when will QE resume. This market IS QE and nothing more. Since hyperinflation is the only way a fiat system can be allowed to die, look for QE announcement soon. There are likely other ways to continue the show though so maybe we will see the Fed devise a novel way to blow up the currency.

We know where we are headed, the details are murky but this path has been traveled by every nation with a now dead fiat currency. These guys know the routine. They will eventually 'get busy' again...and the crowds will cheer and then wonder, a confused look on their faces, when the money becomes worthless.

Mon, 10/20/2014 - 13:53 | 5355747 limacon
limacon's picture

An Elite joke :

"It took me 30 minutes to bury the dead cat bounce ."

"Why so long"

"It was still alive"

Mon, 10/20/2014 - 14:17 | 5355859 bid the soldier...
bid the soldiers shoot's picture

"How far will the stock market rebound go?"

As far as you want it to go, my dears.  Till the end of time.

Civilian time.

Than, of course, we'll begin military time.

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