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.


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

BTC

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Three Charts that Continue to Incline Me to Caution

As a follow up to my post from earlier, I want to point out a couple of observations, one more on the S&P 500, one on Apple and one on the Dow. In all 3 cases, these assets are at resistance in various forms and it’s at least worth pointing out.

Now, on the S&P, I’ve been using a channel from the COVID crash low through the January 24th low, which is a bit arbitrary, but the 1/24 low seemed significant, and at least in the short-term, recapturing that channel will tell us something important. We’re right at it now (green arrow), and it’s not exactly the strongest recapture: more like we’re barely hanging on to it. Reentering the channel with great vigor and then retesting it from above would be preferred (we may still get that, but until we do, we should note that we have not yet). Today’s rally was a bit less than I was expecting (I know it was big, but given the rally off the 2/24 low, I was expecting something to begin looking like that rally).

SPX

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Here’s My Thinking Here

It’s frustrating for me to have untold legions of people criticize me for being bullish here—cautious, to be sure, but yes, generally bullish—but I continue to believe this is only a correction. Now, part of that comes with the territory of having a big account, and putting myself out there, and I accept that. But I don’t easily tolerate emotional people screeching at me, making the flawed assumption that I’m being bullish just because. I have reasons, and I’ve elaborated on many of them recently, but I thought I would bring some of the thoughts together to defend my position to some degree, so that folks know that I am—for all of my many failings—actually attempting to be rational here.

  1. We know that markets, historically, can tolerate rate hikes well, often for quite some time before a bull market ends. And we haven’t actually even seen hikes yet.
  2. We have no 10Y/2Y yield curve inversion here (though it’s moving in that direction), and even if we did, it would mean little to us here today as markets tend to top (on average) six months after such an inversion.
  3. Much of this recent selling has been news-related. Historically, news-related selloffs are almost always reversed.
  4. Historically, wars are, as awful as it is, often not as bearish for equities as we might want to presume. And it’s not even clear yet to what extent we might classify this geopolitical event as “a war,” nor to what extent the U.S. will be involved.
  5. Bear markets are most often associated with recessions. And presently, the economy is still growing, though its rate of change of growth is slowing. Now of course many, many individual names have had outright bear markets, but as far as whole indices, it’s not something we typically see without also seeing recessions.
  6. Bear markets often start on peak euphoria, and frankly, most of the sentiment data seems to point to the opposite: that since the COVID crash low in particular, sentiment has been especially bearish.

I have more, but you get the idea here. I’m not simply shooting from the hip. I am acknowledging that none of this stuff points to a market top. And thus, so far as I can conclude in advance, this appears to be merely a correction. And now that raises a new question: how big and how long? Extremely hard for me to say.

I know that the vast majority of corrections in stock market history take on the appearance of a 3-swing structure of some kind.

And so, even at the January 24th low, I could see a 3-swing move on the S&P 500, like this:

SPX

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Here’s a Thought for You on High Yield Debt and What I Think It’s Not Telling Us to Do Yet

So, I look at lots of risk signals, and I love watching $JNK. Toward the top of the market, I was warning of caution partly because of how high yield debt was performing relative to equities (e.g., here, here). And that turned out to be prudent as we sort of fell apart. But as we continued to fall, and as we’ve entered this range, I’m not entirely concerned now because of many things I’ve discussed before (e,g, here, here). And that is despite junk bonds continuing to look like total trash here.

So here’s the thinking on this:

  • I have a lot of signals that look ok
  • Junk bonds look completely awful

What am I to do? Am I to assume that junk bonds are telling the truth and that everything else is misleading us? Or am I to conclude that the majority of evidence points to not such a bad risk off environment (no crash, no bear market—at least not yet)? And if the latter, then how do I explain junk bonds?

And so here is how I am going to try to explain that. You see, as a refresher—and to save you a ticker lookup—$JNK does look like total shit here:

JNK

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Note: When my work is first published on this website, it is made available to patrons who support my work through my Patreon account. Over time (usually after a period of a few months), I make the work public. To gain access to my work when it is produced, please consider becoming a patron. More information may be found on my About page and on my Patreon page.