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News Flash: Violent, Chaotic Behavior is not Bullish.
*This article was posted to MOTR Research on July 12 th , therefore whenever we mention yesterday, we are actually talking about July 11 th . However , it feels even more relevant now than ever before with the current environment. If you want to get these reports with no delay, begin your free trial today !
Highlights
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As much as we all want to say yesterday’s* price action was bullish, I struggle to do so because the data (below) says otherwise.
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Bull markets are marked by calm, persistent behavior; bear markets are marked by chaotic, violent behavior. Yesterday* was the latter.
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In today’s report, we walk through market performance following 19 similar events since 1987, review the currently precarious state of the market , and remind readers of our gameplan for periods like this.
As much as I want to answer “yes, yesterday’s* rotation was bullish” to all those who have asked me in the last 24 hours, I struggle to do so. At its core, the premise is that non-violent price behavior is characteristic of bull markets, while violent, chaotic price behavior is not. The latter may not be bearish per se but it tends to not be bullish. Let’s look at the data…
Since 1987, there have been 19 instances (prior to July 11 th ) when the S&P was down on the same day the Russell 2000 was up, and the spread between the two was more than 2.00%. Each of those instances are marked by a vertical line in Figure 1. July 11 th saw the 20th such instance, in fact it was the 2nd largest ‘rotation day’ performance spread between the two indices since 1987.
In figure 1, there are a few important things to point out. First, of the 19 instances prior to yesterday*, three of them were followed by higher prices (green arrows), albeit in the first case (12/31/1996), the advance was interrupted by a swift -13% plunge in about three weeks.
This leaves us with the other 16 instances, all of which w ere associated with unhealthy, if not ‘crash-like’ environments. In Figure 1, we highlight two interesting clusters of these events (red arrows) that pre-empted the eventual unwind of what ultimately proved to be epic stock market bubbles: 1999 and 2021.
Both of those clusters contain four instances, meaning that 8 of these 16 remaining events happened right before a major bubble unwind. The rest of them happened either during highly divergent periods or ongoing bear markets and outright crashes. Since today’s environment is clearly highly divergent, and potentially leaning towards a bubble, we should be on notice for the possibility that yesterday’s* rotation was a warning of more turbulent behavior to come, not less.
The table inset in Figure 1 shows the average 1-, 3-, 6-, and 12-month performance following each of these ‘rotation’ events. Also featured is the percent of those various performance windows that were positive. This data can then be compared to the bottom of the table which shows the average performance and percent positive periods since 1987, regardless of price action the day before. The data is colored in red when the performance data following a rotation day is less than any random average period… there is a lot of red .
This is a good time to remind readers that this data is only intended to provide a guide for our expectations going forward. It is not a forecast or an investment strategy. What matters far more is the current health of the market, because that will tell us whether it is positioned to navigate this chaos from a position of strength (leading to a bullish outcome) or weakness (bearish outcome).
As can be seen in Figure 3, the picture is not pretty. As the S&P and NDX have both scored fresh all-time highs, most stocks are not only not going up , but an uncomfortably large percentage are actually trending down . In the short-term (remember, we’re talking weekly charts here), only 39% of the market is in an uptrend (red circle). So most weekly charts are in downtrends, despite the S&P hitting new highs.
The red arrows show that in both the short-term and medium-term ( monthly charts) , the largest trend stage is clear downtrend (‘Dn Trend’). All of this is taking place in the context of the long-term timeframe ( quarterly charts) showing only a slight majority of stocks (55%) to be in a positive trend. Why is this a problem? Because the current rally will unavoidably result in the following condition: the S&P and NDX will then be overbought at the same time that the rest of the market, much of which is already in a downtrend, will also be overbought.
This is also a good time to remind readers that, during ‘non-bullish’ environments such as now, this is precisely why we only buy when oversold. Admittedly, it is harder to do because you typically feel like selling, but that’s why we do it. It is also when we sell puts on uptrending stocks that are oversold and sitting in our systematically derived Trend Support and Momentum Support Zones. When most stocks are back to overbought and in resistance, we will feel more inclined, if not emotionally compelled, to buy, precisely when the risk of being wrong is the greatest.
So, for now, nothing has changed. If anything, this violent behavior only adds to our concerns. We remain fully invested, because we still can’t say conditions are bearish just yet. But we are highly focused each week on the marginal change in the data. We need to see structural improvement in Figure 3 before we can breathe a sigh of relief.
The MOTR Research process has effectively helped identify and navigate every major bull and bear market since the late 1990s. If you want to stay updated with what we are seeing, head on over to MOTR Research for a trial of our research. We publish 20-40 buy ideas each week (and short ideas in bear markets), on top of timely weekly market reports and monthly videos. We have a 30 day free trial , so why not give it a try?
Thank you for reading.
David Lundgren, CMT CFA