Posted | by David Moenning |
What's Next? History Suggests... image

One of my favorite jokes about Wall Street goes something like this: The first time something happens on Wall Street, it's called it a trend. If it happens twice in a row, it's a tradition. And if it happens three times in a row, well, it's darned near a commandment!

I guess it is good news then that stocks managed to close higher for a second consecutive session on Monday. It is also good news that stocks appear to be in "bounce" mode - aka phase two of the crash playbook. And on that score, technicians are saying it is good news that the S&P bounced off its 200-day moving average on Friday and as such, the low of the move is "in."

Given (a) the extent of the decline and (b) the dearth of any news or real fundamental support for the big dive, this argument would seem to have some merit. While Ms. Market can and often does do anything she darn well pleases, it was kind of difficult to justify a 12% decline from top to bottom based on the idea that rates and inflation might rise a little faster than expected.

Therefore, one can easily argue that the successful tests of the 200-day on an intraday basis and the 150-day on a closing basis means that it's time to go the other way for a while.

Speaking of bouncing at key technical levels, it was reported that Friday's timely reversal may have been aided by a report from an influential quant over at JPMorgan. Known as "Gandalf" the analyst suggested the selling attributed to volatility trading and strategies involving volatility targeting (such as risk parity and the like), had run its course. As such, traders had the green light to "buy 'em!" without the risk of being run over by additional selling from the quant crowd.

To be honest, we can't ever really know what caused the algos to reverse course and lurch upward. Which, of course, led the trend-following algos to hop on board. This, in turn, led to a nice rebound in overnight trading, which, of course, led to a solid open on Wall Street. And so it goes.

At the very least, it can be argued that we're seeing a bottoming process unfold. Up, down, up, down, up, up. Yea, that sounds about right.

What's Next?

However, the question on everybody's mind at this stage is, where do we go from here?

So, let's look at the history books to see if we can glean anything from the previous 10% declines in the market.

Going back to 1/3/1928, the analysts at Ned Davis Research tell us the S&P has experienced 96 corrections that measured 10% or more. This means that, on average, the stock market sees a drop of 10% or more a little over once a year. As such, it is important to keep in mind that these things are pretty common.

The average duration of a 10% correction has been about 3 months. And unfortunately, the average decline for the moves that make it to 10% is 19.5%.

In terms of what's next, the odds of a 10% correction turning into a "severe correction" (defined as a decline of 15% or more) is about 45%. This means that just under half of all 10% corrections get worse before they bottom.

It is also a bit discouraging to find that the average return 6 months after the peak is -7.3%. And the returns in the ensuing year have averaged -3.6%.

However, the good news is that an analyst from UBS pronounced yesterday that the key to future returns is the state of the market when the correction began. The stat offered is that when a correction of 10% occurs during a secular bull market, such as we're in now, the average gain over the next 12 months was on the order of 19%.

Thus, the conclusion here was clear - everyone should buy the dip. Got it.

Inflation Data Looming

But from a fundamental perspective, let's remember that we've got what could be a pretty big CPI number on Wednesday. Since much of the macro focus has been on the purported increase in inflation expectations, this number could be a market-mover.

In short, a number that is "too hot" could very well bring the sellers back and sent the market into "retest" mode. But a number that is less than robust could easily embolden the bulls. So, for traders, it's time to place your bets.

For the rest of us, this is probably a good time to take a breath and look for signs that the corrective phase has run its course. This would include LESS volatility and maybe some "basing" action where things get boring for a while. One can hope, right?

Thought For The Day:

Even if you're on the right track, you'll get run over if you just sit there. -Will Rogers

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

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At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.


Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

Mr. Moenning may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.