Stretched to the Limit

There are good reasons to suspect that the bull market in US equities has been stretched to the limit. These include inter alia: high fundamental valuation levels, as e.g. illustrated by the Shiller P/E ratio (a.k.a. “CAPE”/ cyclically adjusted P/E); rising interest rates; and the maturity of the advance.

 

The end of an era – a little review of the mother of modern crash patterns, the 1929 debacle. In hindsight it is both a bit scary and sad, in light of the important caesura it represented. In many ways the roaring 20s were the last hurrah of a world in its death throes, a world that never managed to make a comeback. The massive expansion of the State that had begun in the years just before WW1 resumed in full force as soon as the post-war party on Wall Street ended. The worried crowd that formed in the streets around the NYSE in the week of the crash may well have suspected that the starting gun to profound change had just been fired. [PT]

 

Near the end of a bull market cycle there is always the question of when a decline will begin, and above all, how large will it be. I believe it possible that the retreat in prices will begin soon and that it could possibly even start out with a crash. I will explain in the following what led me to draw this conclusion.

 

2015 – 2018: the S&P 500 Index Moves Up Along a Well-Defined Trend Line

Let us first look at a chart of the S&P 500 Index over the past three years including the major  trend line formed by its rally. Prices moved up steadily along this trend line for a long time, until the advance suddenly began to steepen significantly in January of 2018. Thereafter prices plunged very rapidly in early February, followed by a swift rebound. This rebound appears to have ended earlier last week.

 

S&P from 2015 to 2018 with trend line providing support: for now the trend line still holds.

 

In 1987 the Market Crashes after Breaking Through a Similar Trend Line

Let us now compare the developments of recent years to a chart showing the move in the DJIA from 1986 to 1987 (focus on the general shape of the move rather than details such as percentage gains and duration). The similarities between the patterns are quite stunning.

 

DJIA with trend line, 1986 – 1987. After breaking through the trend line, the index quickly plummeted.

 

In 1986/87 prices also moved up along a rising trend line; there was a similar acceleration of the rally into the peak, followed by an initial test of the trend line and a rebound. After a short while the trend line was tested a second time. When it failed to hold, the crash commenced, soon culminating in a loss of almost 23% in a single trading day on October 19 1987.

 

Whiplash… the bull market mascot one week after the initial trend line test. [PT]

 

DJIA in 1929 – The Market also Crashes Right after Breaking a Major Trend Line

Let us ponder a chart of the DJIA from 1928 to 1929 as our next example, once again with the major trend line that supported the advance. Once again there are strong similarities to both the current situation and the pattern observed in 1987.

 

DJIA with support trend line, 1928 – 1929; once again the market crashed right after it tested the trend line that defined the uptrend for a second time and broke through it.

 

Just as happened both in 1987 and very recently, the market rose along the trend line until the rally suddenly accelerated and peaked; this was followed by sharp pullback and a first test of the trend line, a rebound, and eventually a second test that failed and immediately morphed into a crash.

A particularly dire bear market ensued in this case – by the summer of 1932, the market had lost almost 90 percent from the early September 1929 top (peak on Sept. 03 1929: 381.17 points; low on July 08 1932: 41.22 points).

 

1990 –  A Similar Pattern and Trend Line Break Precede the Crash in Japan’s Nikkei

What about non-US equity markets? One of the biggest bear markets of all time has been underway in Japan since 1990. The next chart shows the Nikkei 225 Index, also including the trend line that served as support in the final years of its bull market advance.

 

Nikkei 225 with major support trend line, 1987 – 1990; prices decline strongly after the trend line is broken.

 

Once again prices rose along a well-defined trend line, and once again the rally accelerated into the peak, after which an initial test of the trend line and a rebound followed. On the second test the Nikkei broke through the trend line and a lengthy and severe bear market began. The decline eventually reached a staggering 82% (the low was made in 2009, almost twenty years after the top).

 

When is the Crash Danger Acute?

In summary, there are very strong similarities between the chart formation that is in place right now and the patterns that could be observed at the pre-crash peaks of the DJIA in 1929 and 1987 and the Nikkei in 1990.

This raises the question whether there are also similarities in the temporal sequence of these patterns. Below is a table that shows the time periods between the most important turning points of the patterns in calendar days after the peak.

 

Time periods between major turning points in past crash patterns

 

The line designated “initial trend line test” shows how many days it took to decline from the top to the first test of the trend line. In 1929 it took 30 calendar days, but recently it took just 13 days (peak on January 26 2018, first test completed on February 08). In short, the length of time elapsing between these two turning points was quite different in these cases.

The second line designated “peak of rebound” shows the number of days from the top to the peak of the initial retracement rally. In the three historical examples of the US in 1929 and 1987 and in Japan in 1990, it was reached after 37 to 39 calendar days, i.e., these turning points were actually quite close to each other.

Currently this would be equivalent to March 02, March 03, or March 06 (at the moment it appears as though the rebound peak may have occurred on February 26. On Feb 27 the market very briefly traded above the range of Feb. 26, but closed lower).

The last line, designated “break of the trend line”, shows how many days elapsed from the peak to the second test, when the trend line was broken and the crash wave began. It is interesting that this happened between 45 to 53 calendar days after the respective bull market peaks of the three historical examples.

 

Important trend line acrobatics… [PT]

 

Once again these events happened quite close to each other; the time interval between the top and the failing retest was almost of the same length. Currently the equivalent time interval would target the time period from March 12 to March 20 for the retest.

More important than the precise number of days is the break of the trend line as such though. For instance, in the sharp decline in 1998 no such trend line break occurred, after the benchmark indexes had rallied along similar well-defined uptrend lines for a very long time;  the strong advance in prices quickly resumed.

 

The Preconditions for a Crash are in Place

Readers may well wonder why such strikingly similar price patterns tend to occur at all. There are probably psychological reasons for these similarities. At first prices rise steadily over a lengthy time period, until euphoria (and the “fear of missing out”) lead to an acceleration of the rally, producing a major peak. Such a phase could be observed in January of 2018, when   the ratio of bullish to bearish advisors according to Investors Intelligence reached an all time high.

What then happens is the opposite of what most investors expect, as prices suddenly decline sharply; initially the pullback tests the trend line successfully. This is what happened in early February this time. By the time the trend line comes into view, sentiment has pivoted completely and has become very bearish, which promptly triggers a rapid rebound. Investors quickly become optimistic again, which paves the way for the decline to resume.

In short, expectations are suddenly disappointed at every turn. The subsequent retest of the trend line is the decisive moment though. If it is broken, there is a significant danger that a crash will ensue. Its psychological function is to thoroughly destroy the faith of investors in perennially rising stock prices.

Will a crash happen this time as well? Crashes happen only very rarely after all – depending on one’s definition, one could well say that a real crash happens perhaps once every few decades. However, the factors discussed above suggest that crash probabilities must at the very least be regarded as elevated in coming weeks.

 

The beast is ever so slightly bruised, but far from vanquished… Crashes are indeed quite rare, and nigh impossible to predict, since sharp run-of-the-mill corrections that don’t end up violating important trend lines cannot be differentiated from those that do ahead of the event. But when a combination of several factors that are known preconditions for crash waves is in evidence, then it is definitely worth to consider the possibility. It is irrelevant that crashes are “normally” rare events. For one thing, they are less rare when the above discussed confluence of price patterns, sentiment and valuations is present; and secondly, if a low probability event harbors very large expected effects, it is definitely a good idea to actually be prepared and have a plan. Why risk ending up as yet another deer in the headlights? The landscape will already be well stocked with those if push actually comes to shove. [PT]

 

Charts by: StockCharts, ShareLynx, Dimitri Speck

 

Chart and image captions by PT where indicated

 

Dimitri Speck specializes in pattern recognition and trading systems development. He is the founder of Seasonax, the company which created the Seasonax app for the Bloomberg and Thomson-Reuters systems. He also publishes the website www.SeasonalCharts.com, which features selected seasonal charts for interested investors free of charge. In his book The Gold Cartel (published by Palgrave Macmillan), Dimitri provides a unique perspective on the history of gold price manipulation, government intervention in markets and the vast credit excesses of recent decades. His ground-breaking work on intraday patterns in gold prices was inter alia used by financial supervisors to gather evidence on the manipulation of the now defunct gold and silver fix method in London. His Stay-C commodities trading strategy won several awards in Europe; it was the best-performing quantitative commodities fund ever listed on a German exchange. For in-depth information on the Seasonax app click here (n.b.: subscriptions through Acting Man qualify for a special discount. Details are available on request).

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

2 Responses to “US Stock Market: Conspicuous Similarities with 1929, 1987 and Japan in 1990”

  • jks:

    Another parallel between now and the 1929 market crash is trade protectionism. It was the threat of the Smoot-Hawley tariffs that pushed the market over the edge. The Cato Institute wrote an article outlining the sequence of events leading up to the crash that should be required reading to all the trade scapegoaters:

    https://www.cato.org/blog/smoot-hawley-tariff-great-depression

  • killben:

    “However, the factors discussed above suggest that crash probabilities must at the very least be regarded as elevated in coming weeks.”

    Add in the following facts…

    1. ZIRP and NIRP world over with the Fed trying to desperately raise rates and others not in a position to follow suit
    2. Coordination action by the central banksters from 2008, now all-in. What happens when they all try to get out?
    3. Market has conditioned the Fed (and other central banksters) to come running with its tail between its legs the moment it sneezes
    4. Global debt has increased by $57 trillion in the seven years following the financial crisis (source: https://www.theguardian.com/news/datablog/2015/feb/05/global-debt-has-grown-by-57-trillion-in-seven-years-following-the-financial-crisis), making it almost impossible to raise rates
    5. Pension funds in distress due to ZIRP and NIRP
    6. Central banks bloated balance sheet
    7. Markets at elevated levels, meaning to saying anything can be the last straw that broke the camel’s back
    8. The epicenter for the next crisis could well be Europe. Goodbye EU, Welcome ENU (European Non-Union)
    9. Central banksters on the ropes
    10. Papering over may not work for ever.

    Interesting times indeed!

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • As the Madness Turns
      A Growing Gap The first quarter of 2019 is over and done.  But before we say good riddance.  Some reflection is in order.  To this we offer two discrete metrics.  Gross domestic product and government debt.   US nominal GDP vs total federal debt (in millions of USD) – government debt has exceeded  total economic output for the first time in Q4 2012 and since then its relative growth trajectory has increased – and it seems the gap is set to widen further....
  • A Trip Down Memory Lane – 1928-1929 vs. 2018-2019
      Boom Times Compared It has become abundantly clear by now that the late 2018 swoon was not yet the beginning of the end of the stock market bubble – at least not right away. While money supply growth continues to decelerate, the technical underpinnings of the rally from the late December low were actually quite strong – in particular, new highs in the cumulative NYSE A/D line indicate that it was broad-based.   Cumulative NYSE A/D line vs. SPX – normally the A/D line...
  • Long Term Stock Market Sentiment Remains as Lopsided as Ever 
      Investors are Oblivious to the Market's Downside Potential This is a brief update on a number of sentiment/positioning indicators we have frequently discussed in these pages in the past. In this missive our focus is exclusively on indicators that are of medium to long-term relevance to prospective stock market returns. Such indicators are not really useful for the purpose of market timing -  instead they are telling us something about the likely duration and severity of the bust that...
  • Debt Growth and Capital Consumption - Precious Metals Supply and Demand
      A Worrisome Trend If you read gold analysis much, you will come across two ideas. One, inflation so-called (rising consumer prices) is not only running much higher than the official statistic, but is about to really start skyrocketing. Two, buy gold because gold will hedge it. That is, the price of gold will go up as fast, or faster, than the price of gold.   CPI monthly since 1914, annualized rate of change. In recent years CPI was relatively tame despite a vast increase in the...
  • Unsolicited Advice to Fed Chair Powell
      Unsolicited Advice to Fed Chair Powell American businesses over the past decade have taken a most unsettling turn.  According to research from the Securities Industry and Financial Markets Association, as of November 2018, non-financial corporate debt has grown to more than $9.1 trillion [ed note: this number refers to securitized debt and business loans, other corporate liabilities would add an additional $11 trillion for a total of $20.5 trillion].   US non-financial corporate...
  • The Liquidity Drought Gets Worse
      Money Supply Growth Continues to Falter Ostensibly the stock market has rallied because the Fed promised to maintain an easy monetary policy. To be sure, interest rate hikes have been put on hold for the time being and the balance sheet contraction (a.k.a.“quantitative tightening”) will be terminated much earlier than originally envisaged. And yet, the year-on-year growth rate of the true broad money supply keeps declining noticeably.   The year-on-year growth rates of...
  • What Were They Thinking?
      Learning From Other People's Mistakes is Cheaper One benefit of hindsight is that it imparts a cheap superiority over the past blunders of others.  We certainly make more mistakes than we’d care to admit.  Why not look down our nose and acquire some lessons learned from the mistakes of others?   Bitcoin, weekly. The late 2017 peak is completely obvious in hindsight... [PT]   A simple record of the collective delusions from the past can be quickly garnered from...
  • The Gold-Silver Ratio Continues to Rise - Precious Metals Supply and Demand
      Is Silver Hard of Hearing? The price of gold inched down, but the price of silver footed down (if we may be permitted a little humor that may not make sense to metric system people). For the gold-silver ratio to be this high, it means one of two things. It could be that speculators are avoiding the monetary metals and metal stackers are depressed. Or that something is going on in the economy, to drive demand for the metals in different directions.   As a rule the gold silver...
  • The Effect of Earnings Season on Seasonal Price Patterns
      Earnings Lottery Shareholders are are probably asking themselves every quarter how the earnings of companies in their portfolios will turn out. Whether they will beat or miss analyst expectations often seems akin to a lottery.   The beatings will continue until morale improves... [PT]   However, what is not akin to a lottery are the seasonal trends of corporate earnings and stock prices. Thus breweries will usually report stronger quarterly earnings after the...
  • Bankrupting Coffee Shops - Precious Metals Supply and Demand
      Coffee, Milk and Gold Last week was holiday-shorted due to Good Friday (it’s not an official holiday in the US, but it is in the UK. And this week’s report is a day late due to Easter Monday). The price of gold dropped $15, but the price of silver rose ¢4. Perhaps silver traders got word that we are paying interest on silver, which gives people a reason to hold silver? J   A silver bar plus interest...  [PT]   The discussion in the opening essay [which can be...
  • Kashmir: The Constant Conflict
      Threats of Nuclear War On February 26, 2019, the Indian Air Force, for the first time since 1971, conducted a raid inside Pakistan, and allegedly hit a terrorist training camp, killing more than 250 terrorists. Pakistan showed photographs of damage to a tree or two. According to Pakistani officials, no one died and no infrastructure was damaged.   Mirage 2000 warplane of the Indian Air Force in medias res. [PT] Photo credit: hindustantimes.com   It is hard to...

Support Acting Man

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!