Finding the end of the bear market of 2022 (Survivor Series Part 4)
You know what's crazy about this draw up I did?
We nailed the intermediate rally exactly (so far at least...).
Do remember that my last series of posts were about nailing the intermediate rally that we mentioned could be worth 8%-15%, and not what happens after. What happens after depends on shifts in fundamentals and earnings. It could go higher after awhile, or hit new lows... but we nailed the initial big move. From the low of 3500 to the high of near 3900, that's about 12%.
Look at the date. I drew up a possible future for the $SPX on 3 Oct 2022, in the post, An intermediate bottom in the S&P500 now?
One month later today, Nov 4th, 2022, we got that intermediate rally and the markets literally got rejected at the 3900 level, which is what I drew a month ago.
I posted this chart of the Dow Jones the very day of rejection.
Some of my readers who are traders took 2/3s of their profits at that level and wait to see what happens next. I think that's prudent.
Do I have a time-machine?
I could not know for certain how exactly the markets would go, but I knew what a few possible price configurations would be, and I knew there should be a intermediate rally. I only drew one of the most likely configurations. However, of the last 5 times I publically drew price configurations (which I can only do at critical points in the market), I was more or less correct on 4 of them. That's a high hit rate, thank God.
My survivor series will let readers have a glimpse of all the work that went into projecting that perfect intermediate move to 3900.
Anyway, this might be my last post for the year.
I mentioned a few weeks ago I am going to be focusing other things, like the writing of my book of my Christian testimony and also spending more time focusing on health.
3 weeks ago, I had abdominal pains that ended up being appendicitis.
Just 2 days ago, I had to go to the hospital because I had waves of bad abdominal cramps that I never quite experienced ever. They gave me anti-cramp pills and asked me to monitor myself because I didn't have the severe symptoms, like fever and chills. If I am still worried about the random nature of the cramps, so return to the hopsital in a couple days.
Thanks fo keeping me in prayer.
Now to the post.
This is part 4 and maybe the last part of this Survivor Series... for now.
I wrote this Series to give an indepth but "introductory" look into how I navigate the bear/bull market cycles and how to obtain a long, mid, short term plan for investment and trading. If you've been in the stock market for awhile, you know the stock market can be treacherous at times. Markets can reverse on no news. Markets can go up on bad news and go down on good news. There are many variables that can determine the short, mid-term and long term cycles of the market and we can get lost in the vast amount of data and opinions out there.
I also wrote this series for my future kids and family so they can have a glimpse of how Ken managed to go from a small-time trader to what I am today.
A quick recap.
In the Rubber Band is Stretched, we indicated just a few days before the intermediate rally that the probability of an intermediate rally was high. This blog speaks to knowing when a rally might happen before it happens.
In Finding the end of the bear market of 2022 (Survivor Series Part 1), we explored how bear markets and official recessions far from coincide in terms of times. In some extreme cases, by the time an official recession was called, the bear market was almost over. We then explored potential downsides in bear markets based on historical cycles based on the size of the recession. This gave us an idea how to investment with clarity as we go into those levels. TL:DR, if we break the recent lows in the $SPX, it's probably a good thing to start averaging in as a long time investor, because we are likely in the 2nd half of the bear market already.
In Finding the end of the bear market of 2022 (Survivor Series Part 2), we explored some of my favorite breadth and "canary" indicators that I use to measure how oversold or overbought we are. Using common technical indicators like RSIs are only gauges because they only use historical price of the $SPX to tell you how oversold you might be. It's "intuitive" to think that for instance, if the price went down 10 days in a row that a bounce should occur soon. However, there is no "scientific" reason with explanatory power in the internals of the market that validate such a claim. Hence, it is important to be able to slice into specific parts of the market to get a sense if the market is ready for a bounce. We talked about margin debt levels, canary stocks (for markets to recover, these stocks might recover first), put/call option levels, how to measure smart money and dumb money.
I also revealed an unusual way of gauging if the markets have overreacted based on the fundamentals by looking at manaufacturing new order y/y% change and broad market y/y% change spreads.
The blue lines is where the spreads hit those extremes. Only in 2009, we had an intermediate rally that went into new lows. Still, it was an intermediate rally.
These were so important to determine the intermediate rally while the news was still very bearish, as the popular narrative (that restarted today) that the FED was going to tighten rates to generate a recession was inevitable.
In Finding the end of the bear market of 2022 (Survivor Series Part 3), we explored the importance of Intermarket Relationships to help us get a hint on which part of the stock market cycle we are on. By knowing which part we are on, we can have an idea of HOW different asset classes are supposed to behave. Or better, by seeing how different asset classes are behaving, we can know which part of the stock market cycle we are in.
TL:DR: We are likely in late expansion, early recession phase. This means that for there to be a meaningful bottom in the stock market, we will likely need to see bonds recover as well. So long as bonds continue to sell off, it exerts a headwind on stocks.
Now we start Survivor Series Part 4.
As I mentioned earlier in this post, we nailed the intermediate rally. We gave warnings it would happen a week before it did, and then posted on the first day that an intermediate rally was likely starting. This was our original set up on 3 Oct 2022.
In all actuality, I cannot guarentee if price will continue to breakdown into new lows, or if the intermediate rally will consolidate and then move higher. Technicals and sentiment can predict the intermediate rallies, but for there to be a prolonged bullish move, it does require solid fundamental to substantiate it.
This is why that at points like where we are now (that the major oversold condition is over and we we could be in the 2nd half of the rally, or it might fail) we require some discipline or trading systems to guide our decision making.
Here would be an example of elementary technical analysis and a simple trading set up.
CONVENTIONAL MACD daily crossover set up:
This works best if you already have a strong fundamental opinion on the markets and economy.
You will the MACD crossover as a buy/sell trigger.
If you think that the markets are going to go lower on the longer term, then you wait for the the black MACD line to cut below the red signal line to be risk off.
If you think the markets are going to be higher on the longer term, then you wait for the vice versa to be risk on.
I did the liberty of drawing all the buy/sell points if you adopt this strategy.
In addition, If you are risk on, you would buy on dips. If you are risk off, you would sell more on strengths.
Can plan your moves ahead of time.
Can be late. You will probably miss the first 20% of a full move.
You might get whipsawed from time to time based on random walks in price. For instance, in the recent intermediate bottoming, there was a whipsaw. Are traders disciplines to get in, then get out, and then get back in, eating a small loss to do so?
Here's the thing.
The strategy used above is very well known, and the parameters on the MACD (12,26,9) are default on most trading platforms. There isn't an actual reason why these parameters are valid today on the $SPX.
As the saying goes, you can't do much better than others if you are doing what many others are doing.
How to do a bit further? How to improve on the strategies like the MACD?
I think it's not controversial to say that the majority of people who have uncommon success in the stock market tend to have their own proprietary trading strategies, and are using methods that the majority aren't using.
For myself, I devised what I call a smart trader indicator by using option trading data.
This option trading gives me what are the "risk off" and "risk on" zones so I can use this to augment the technical indicators like the MACD above. Sometimes, this indicator disagrees with the MACD and when it does, it makes me pause.
How to use:
The upper chart is just the price of the $SPX.
The middle chart is the Smart Trader Indicator, the blue line that's moving within the blue upper bound and red lower bound.
The lower chart is a momentum measure of the Smart Trader Indicator.
A Risk ON status is triggered when both the SMI is above 1.1 and drops below it AND momentum makes a downward cut (like the beginning of Oct where the intermediate rally started).
A Risk OFF status is triggered when both the SMI is below 0.95 and cuts above it AND momentum makes an upward cut.
This SMI is ABOUT TO FLASH INTO RISK OFF... weakness time.
While the MACD on the SPX in the earlier chart uses the price history of the SPX itself, this indicator uses put and call option data. it is measuring the shift in trading activity of option traders.
In the last 6 months, it did a relatively good job in gauging time in the markets that were generally bullish vs bearish.
Makes a great confirmation indicator to price momentum indicators of the $SPX like the MACD.
it can even give early warnings the MACD might not.
This indicator is data-mined it is NOT evergreen. I optimized in on the recent 6 months of trading activity. If you go back a year ago, the signals worked less effectively. This means the effectiveness of this system is based on the assumption that the regime of how traders react will the same as in the last 6 months. So, it's important to gauge what's in the social imaginery of the stock market to see if it is still the same. If there are no game-changers fundamentally in sight, it's possible the trading regime is the same. If the only major issue in the markets is the FED tightening to recession, this indicator may still be useful.
The SMI developed is not what I consider a true "evergreen" quantitative trading system (but could be if further tweaked), and it has some explanatory power in explaining the market cycles, but not in a robust way. However, it is still better than the MACD strategy in terms of explanatory power.
Finally, I give an example of a proprietary indicator that I consider robust and evergreen, these are the types of work I feel we need to do to get a big edge in the markets.
This is the QuantZombie SIlver ReVAL Major Top / Bottom Quant Indicator.
No, I can't tell how I devised it.
But it cuts through ALL the noise of the markets and opinions of traders that try to argue when the bottom of the market is in.
This model shows you when the absolute bull market of the silver starts.
Such a model is extremely rare.
I did not use any technical momentum indicators, nor did I use things like "demand-supply" of physical silver (which doesn't do a good job predicting bottoms). It's a factor model with other asset classes. The explanatory power of it is that it tracks how extreme things have to be before big players will feel too tempted to move some of their other assets into silver despite the news.
And if you want to ask, the model worked again perfectly in 2020, during the COVID crisis.
This work is probably what I am most proud of, because it took 4 months of research.
Once we determine the potential downsides based on historical bear markets...
We can use daily technical indicators or prop indicators to have emotional free investment decision making on the short term. Optimized indicators like the SMI are super effective, until they don't work anymore.
For a forewarning of intermediate bottoms forming, use breadth, canary and co-incident indicators.
For an outsized edge in the markets, have to find methods not commonly used.
The SMI is about to flash into RISK OFF time, so unless there is a sudden improvement in bullish trading behavor there will be likely shot term weakness.
If I had to guess at this moment, it seems like we might drift lower to new lows eventually in 2023, especially if the FED remains hawkish. Cycles speaking, November and into mid December is supposed to be a good month for stocks, so if I had to guess, I don't think we will plunge down yet.
However, when this happens, wait a while, and then this will be a good zone to accumulate stocks for long-term holding because we will be >-27% on the $SPX which is the average downside of a bear market with no recession (-39%ish for a bear market with recession)... so we will be in the -27% to -39% zone.
I suspect we won't go into the -39% zone unless something really breaks in the economy.
Also, using Google as a guide, at the price now, it's trading at a FW PE of 17x.
I remember that at the bottom of the 2009 GFC, it was trading around 15x fw PE. So, unless the earnings of Google drops even further a year out, that's only a -15% downside more to get to extreme low levels. Of course, one could argue Google doesn't have the same growth prospects now than in 2009, but still, it's a good quantitative guide.
The economic data will likely not quite have recovered yet in 2023... so try to choose strong companies with cash flow and manageable debt as core holdings. High debt companies with no earnings should only make up a smaller speculative part of your investment.
This might be my last post of the year.
Let not your heart be troubled.
Pain is temporary, Grace can see you through.
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