Extreme Caution Remains Warranted: A Strong Further Decline May Still Lie Before Us

May still lie before us. I do not possess a crystal ball. But, there is a technical structure I am observing that may suggest a further decline ahead of us in risk assets. This article will lay out the idea in detail.

I am not here to confirm or deny anyone’s bullish or bearish expectations for the markets. I endeavor, instead, to objectively assess the situation in anticipation of its unfolding. In the spirit of that, let us summarize the merits of the bullish and bearish cases, respectively:

Bullish case:

• It has been my expectation that a reduction of pandemic-related restrictions combined with the weak Omicron variant (leading to herd immunity) could produce a feeling of worldwide relief that could support a very strong appetite for risk assets for quite some time, perhaps even several years
• We seem to have not—by many sentiment measures—experienced the type of euphoria we typically see at major market tops
• Many of the destroyed growth names have already endured terrible and lengthy bear markets and if those were all to end soon, their next moves could be tremendously bullish
• We will be hard pressed to find historical examples of markets topping prior to rate hikes being implemented, and, in fact, they often top long after the rate hike cycles begin (and there has been no yield curve inversion, GDP continues to grow, etc., etc.)
• There is an enormous amount of “cash on the sidelines,” some estimates I see place that in the trillions of dollars.

Bearish case:

• The short and intermediate trends remain decidedly down, and if we go much further, longer term trends may also become threatened
• The events in Europe may cause rapid-onset contraction in many economies (Russia’s of course, but also, say, of Germany’s, as 70% of their energy supplies come from the now heavily sanctioned Russia—see how the $DAX has interpreted these events)
• A rapid contraction will of course not been seen by leading economic data
• Any such unanticipated contraction may become contagious

Weighing these two groups continues to lead me to believe that we are in a correction, and not a bear market. A point of clarification: when we use the phrase “bear market,” we can mean two things: oftentimes, we mean by that a long, and drawn-out decline in asset prices lasting many months or years; or we can mean a “technical bear market,” typically understood to be a decline of 20% from a recent high in a major index (such as the S&P 500). When I conclude that a “bear market” continues to seem less likely to me here given the totality of the evidence listed above, I am referring to the former sense and not the latter.

And one thing that I will be suggesting today is that I am open to the latter. That is to say: though I do not expect anything like the GFC or the dot-com bubble bursting, I am open to some further lows ahead that may even put the S&P 500 in a “technical” bear market.

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To begin, I would like to look at the basic structures on $BTC. Where liquidity flows, so flows the Bitcoin candles, and it’s far easier to use technicals on a single chart like this than to try to do so on a complex of variable risk bonds or something like that.

Some general notes:

• It has the appearance of two, consecutive head and shoulders patterns
• The top of the one on the left coincided with the beginning of the decline of all the high growth names
• The top of the one on the right coincided with the top of the Nasdaq
• Thus, if we can draw some conclusions about this asset’s future, they may assist us in predicting the course of equities

Now differences between the two head and shoulders patterns are interesting:

• The right shoulder of the one on the left never seriously broke down below its respective neck line; the right shoulder of the one on the right did
• The right shoulder of the one on the left developed into a falling, bullish wedge; the right shoulder of the one on the right has produced (so far) a far more directionally agnostic wedge. Though symmetrical triangles are understood to be directionally agnostic (the “bullish divergence” on the RSI many believe they see is rendered null and void as no new low in price is present), following a steep decline, they are perhaps more reliably interpreted as “continuation wedges,” which gives the present picture a far more bearish look than how things looked last summer

So let us zoom in to the one on the right. Everything from the top looks like one basic structure (it may be a 3-, or even 5-wave move, but it seems self-contained). Always the same motion: down and to the right until January 24, when it clearly changed character and started going simply sideways.

And so we can simply call it “A.” And if that is an “A,” we would expect it to be followed by a “B,” and lo and behold, “B’s” are often triangles and that sort of looks exactly like what we’re building right now. My earlier thoughts have been that we will start to rally impulsively up from here (more often safe to give bulls the benefit of the doubt until we cannot), but Friday’s drop renders that interpretation less credible now. If we were impulsing up out of the January low, we do need to move up in price, and so far it’s now more sideways and so we need to listen to that. And so we may now justifiably label Bitcoin like this:

And you can see the trouble: where there is a “B,” there should also then be a “C.” No idea how low it can go just yet, but if it breaks down, this suggests to me that we’re perhaps only about halfway though the correction. Yeah. And it’s the possibility of that that I wanted to alert you to because if it’s right, we may see a significant drop ahead of us in the coming weeks.

If Bitcoin had simply rallied further (where I have my orange “C”) this could have been averted, as things would have looked far more bullish and we would have moved on from the threat of the head and shoulders pattern. It would have presented us with a very bullish signal (I noted some of that here). We have no such signal now.

Let’s review the Bitcoin possibilities, to try to capture reasonable expectations for future local asset price motions. If we’re in the orange “D” it should be three waves, one of which is probably done here. So, (follow the green path with your eyes) we would expect to go up (a bit), then down (to “D”) then up again (for “E”) then down again bigly for “C.” So: first up, then down, then up, then down.

And so, let’s now extend this thought. If we’re in a “B-wave” in crypto, it’s very possible that we’re also in a “B-wave” in equities. Let’s stick with the S&P.

I continue to think that this present move we are in is not yet complete (last discussed here). And if we’re also in a big macro, “B-wave,” then we may need to go up (a bit), then down, then up, then bigly down. Same basic motions as Bitcoin may move (and if this happens: I don’t recommend trying to long the “E-wave,” they can often fail very early).

And finally, as it turns out, this solves a niggling thought I’ve been having, namely, that oil is primed for a big dump very soon. My last count on it was here (on the counts page), and though it’s been stronger than expected in the last couple of days, the wild volatility it’s seen is very consistent with tops. What’s been niggling about that thought is that I’ve been expecting the February 24th low in equities to hold, but it’s difficult to square that with the expectation for oil to have a major correction. Oil can go up while stocks go down (that is common), but it’s far less likely for oil to go down while stocks go up. You hear the difference between those? In other words, when oil corrects, very often so do equities. And the magnitude of the drop I expect in oil did not easily jive with the thought of a major low being in place for equities.

So, viewing it all this way places everything in harmony, which to my mind strengthens the idea. Equities, Bitcoin, finish B-waves, then drop in a huge C; oil has a major correction, and all of this happens together. All of it multi-week.

So that’s the thought folks. One more thought for you, this on the $VIX.

In bullish trends (for equities), we like to see it spike, then retrace sharply. And it’s just not doing that here. This whole last few weeks has the look, not of a spike, but of consolidation. And way up here at these fan lines. And that makes me think it’s going to build something bigger.

Very last point: I could be completely wrong. There are two outcomes in which I may be:

1. If the market actually really is bullish, we will know right away. Bitcoin, for instance, should moon and blast through that neckline in the charts above. We do that, great. Let’s moon. And for equities (S&P in particular), we would need to see a huge move, probably to 4740 before I could feel confident that we will not head lower.
2. The other option is that we’re not in a 5-swing “B-wave” in Bitcoin and equities, but rather in a 3-swing “B=wave” in which case, we will simply fall apart sooner rather than later. If we see that kind of weakness now, all rallies may be short-able for weeks to come.

So, that’s in case I’m wrong, but let’s see how this week gets going.