Sharp Market Gyrations Could Imply an Inflection Point

The path to a robust political economy must begin with treating political decision making (and the incentives and information embedded in that process) in the realm of policy making not as a footnote caution, but at the very beginning of the analysis.-Professor Peter Boettke

Violent gyrations in the equity markets usually occur during inflection or reversal periods of major trends.

While the current upside swing could reflect a bottoming phase, on the other hand, it could also reflect a transition towards a downside bias—a bear market.

For example, in 2007, after the first jolt from the market peak in July, both the major bellwethers of the US and the Philippines, the S&P 500 (blue-bar) and the Phisix (black candle), dramatically recoiled to the upside (red rectangles).

The initial rally saw both indices BROKE out of the resistance levels (green vertical lines) but eventually faltered. The second downswing had almost been a miniature replica of the first violent reversal.

Seen in the lens of a chart technician or chartist, such dynamic represents a chart pattern failure, where whipsaw motions can be identified as ‘bull traps’—or as investopedia defines[1],

A false signal indicating that a declining trend in a stock or index has reversed and is heading upwards when, in fact, the security will continue to decline

Consequently, following the two failed patterns which diminished the vim of the bulls, the bears assumed dominance.

Don’t Get Married to an Investing theme

I am NOT suggesting that today would be a repeat of 2007-2008.

I keep pounding on the fact that patterns only capture parts of the reality, where the motion of time will always be distinctive with reference to the changes brought about by people’s actions, as well as, the changes in the environment.

It would signify a monumental folly to bet the farm based on the expectation of pattern repetition alone.

And one of the major difference between today and 2007-2008 as I wrote last September[2]

Central bank activism essentially differentiates today’s environment from that of 2008.

As I explained before[3], my bias outcome is for a non-recession bear market.

I think current US markets will likely exhibit symptoms of the non recession bear markets of the 1962 (Kennedy Slide) and 1987 (Black Monday).

Charts from Economagic

And this should be reflected on global markets too

But exposing risk money based on personal biases can be very costly.

Individual expectation of the marketplace and reality usually depart. We DO NOT and CANNOT know everything, and should humbly accept such truism. The desire to see certain outcomes, when facts present themselves to the contrary, will inflict not only monetary losses, but most importantly, mental or psychic anguish from stubborn DENIAL.

This explains the popular trading maxim “Don’t get married to a stock.” Rephrasing this, we should NOT get married to an investment theme.

Prudent investing suggest that we should be taking action based on theory and backed by evidences which either confirms or falsifies it. Confirmation means that we can position to gain profits while a non-confirmation should impel us to consider exiting positions regardless of the profit or loss standings. Learning to manage the state of our emotions reflects on our degree of self-discipline.

And since our understanding of the marketplace shapes our expectations and our attendant actions, we need to seek constant improvement. Expanding our horizons should improve the batting average of our profitability or returns.

Going back to the financial markets, it has been my understanding that the principal drivers of the global financial markets has been the actions of political authorities. Their actions do NOT merely influence the markets, current policymaking via accelerating dosages of inflationism, myriad forms of trading controls and the imposition of byzantine financial and bank regulations represent as direct acts of market manipulation.

Political insider trading not only distorts price signals but importantly politicizes the distribution of gains towards the political class and their benefactors.

In short, in the understanding of the above we just should follow the money.

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[1] Investopedia.com Bull Market Trap

[2] See Definitely Not a Reprise of 2008, Phisix-ASEAN Equities Still in Consolidation, September 18, 2011

[3] See Phisix-ASEAN Market Volatility: Politically Induced Boom Bust Cycles October 2, 2011

The Bullish Case: It’s Blood On The Streets!

``Many momentous historical developments occur without the participants fully realizing what is happening.” George Soros

It’s been reported that losses in Wall Street has hit $2.4 trillion this week and $8.4 trillion for the year (Forbes) while the Phisix lost some P 554 billion or about or about $11 billion over the week (inquirer.net). On percentage basis, the Phisix lost almost the same as Wall Street down by over 18% and is down 45% year to date against the US bellwether Dow Jones Industrials at 39% and S & P 500 at 42%.

As we have pointed last week, the US seems fast catching up on the Phisix on an apparent race to the bottom. But the optimistic angle for the Phisix, which used to be high beta or “high risk-high return” seem to have transformed into “low beta”. In short, US markets appear to be underperforming the Phisix on the downside as well as the upside.

Yes admittedly the overwhelming power of the global bears eventually did catch up with my “divergence” view from which the Phisix struggled to maintain but eventually succumbed. But nonetheless, if such outperformance manages to hold then come the time when the global markets begin to stabilize or consolidate we should see a faster recovery for the Philippine benchmark.

True, the technical breach from support levels signals the return of the bear market, but it is unclear if we could go deeper.

The optimistic case:

Figure1 BBC: Market Crashes Through The Ages

In Figure 1 from BBC which we have shown in August 2007 and August 2008 highlights the worst performance of the Dow Jones Industrials in terms of one day falls and worst bear markets relative to the scale of losses.

Since each crisis has its own tale, this week’s drop 18.2% is one for the history books (marketwatch.com). Nonetheless, the 7.3% drop last Thursday will be as included as part of the largest one day loss and where the weekly loss looks like the extended variant (instead of one day, it became a one week) of Black Monday Crash of October 19^th 1987.

But from the technical, sentiment, valuation point of view these events are starting to look better.

One, the Dow Jones Industrial’s historical bear markets suggest that the biggest loss EXCLUDING the GREAT Depression has been around 40-50% (right pane) which means unless you believe that the US is faced with the prospects of a great depression, this record loss could herald a near, if not an interim, or even a major bottom.

The Dow Jones Industrials has already exceeded the degree of losses incurred from its 2000-2002 bear market (36%).

Figure 2: stockcharts.com: Fear Index and Capitulation Signals

Next, technical indicators point to severely oversold conditions to the point of ‘capitulation’ (see figure 2) or as per investopedia.com, ``capitulation is associated with "giving up" any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. True capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling.” (highlight mine)

Meanwhile the Fear index (topmost pane), as measured by the VIX is at confounding record highs. In previous occasions, the normal highs recorded were at over 30s (red vertical lines) which coincided with interim bottoms. This extraordinary fear is worth taking note of. Likewise the oversold conditions seem to be corroborated by the Relative Strength Index (RSI), seen at bottom pane, which is at below 30.

Figure 3: US Global Investors: Valuations Halved!

Nevertheless market actions appear to be pricing in a significant slowdown in global economies, according to Frank Holmes of US Global Investors (highlight mine), ``Trailing price-earnings ratios for global equities have been slashed in half since last year, as seen in the chart below. This is true regardless of whether financials are included in the calculation. In October 2007, the Factset Work Equity Index (10) generated a trailing P/E ratio of 18; that has now fallen to nine times earnings.

``Barclays made another important observation: The de-rating has been in response to the deteriorating economic climate. Basically, there’s been a traffic jam of inflation and credit shocks that has generated a global financial panic.”

So from the above perspective, we remember the famous contrarian advise of Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, who reaped a fortune from the ensuing panic during the Napoleon’s Battle of Waterloo as saying ``Buy when there's blood in the streets, even if the blood is your own!” (investopedia.com)