- two gap down days with the last day representing a 2% drop;
- violation of and close solidly below the trailing 20-day low;
- very heavy volume on down days;
- close at low of 2% drop;
- only 3% off high after very extended (19.8% since July lows) advance;
- solid violation of breakout point at A that was almost a mirror image of the most recent sell-off, meaning all the price action from mid-December to the present could be viewed as a bull trap (a failed breakout);
- "2b" top (minor) in place when prices took out the 184.69 recent high but collapsed back at 184.94.
- violation of a 5-week flag formation above the breakout point at A, and more recently a violation of a higher, tighter 5-day flag formation.
- implied volatility (VIX) surging off of an extremely low level (low levels of implied volatility are loosely correlated with bull markets (and complacency); higher levels are associated with choppy or falling markets; surges in VIX occur when prices plunge.
Note that the sharp rise in the S&P 500 in the past year is not bearish per se since the market tends to perform better when it has risen or fallen sharply over the past year and most market gains followed modest gains and losses.
Extending the lookback period to 3 years also does not raise alarm bells per se. The S&P 500 rose 47% over the past 3 years, putting it in the top quartile of trailing 3-year returns since 1948, but the average subsequent 12-month change in the S&P 500 didn't turn dismal until the 90th percentile of 3 year S&P 500 changes (58.3% and above).
n:
|
Past 3 year S&P 500 change from:
|
… to:
|
Next year's S&P 500 change:
| |
Min-10%
|
7
|
-40.1%
|
-13.95%
|
17.47%
|
10-25%
|
9
|
-14.0%
|
6.82%
|
4.69%
|
25-50%
|
15
|
6.8%
|
27.55%
|
9.86%
|
50-75%
|
16
|
27.6%
|
44.03%
|
6.79%
|
75-90%
|
9
|
44.0%
|
58.34%
|
8.35%
|
Fundamental reasons, although less reliable in my book, are overall bearish.
China, the world's second-largest economy, is showing signs of stalling and even of a credit crunch of sorts.
Europe, a United States major trading partner, is still mired in extremely weak growth with high, persistent unemployment.
Major problems seem about to implode the economy of Turkey.
Interest rates in the United States have risen sharply. The yield on the 10 year Treasury note has doubled from 1.394% in July, 2012, to 2.735% currently (although the yield topped 3% in December, 2013). The year-over-year change in the 10 year yield is 37%, putting it in the top decile (which ranges from 22% to 76%). When the annual percent change in the 10 year yield has been 22% or higher, the market has only gained .1% per month on average (1.2% annualized). For comparison, the median percent change in yield (ratio minus one, not difference) since 1953 has been 1.44%, and the market only rose on average the next month following months in which the yield change was at that level or below. The stock market tends to be very inversely sensitive to changes in interest rates, doing poorly when rates are rising and making most of its outsized gains when rates are falling.
n:
|
10 year Treasury yield 12 month change from:
|
… to:
|
Next month's average S&P 500 change:
|
Annualized:
| |
Min-10%
|
72
|
-48.2%
|
-20.78%
|
1.71%
|
22.6%
|
10-25%
|
107
|
-20.8%
|
-11.58%
|
0.60%
|
7.4%
|
25-50%
|
179
|
-11.6%
|
1.44%
|
1.04%
|
13.2%
|
50-75%
|
179
|
1.4%
|
11.36%
|
0.51%
|
6.3%
|
75-90%
|
107
|
11.4%
|
22.19%
|
0.10%
|
1.3%
|
90-Max
|
71
|
22.2%
|
76.28%
|
0.10%
|
1.2%
|
Of course, these are general trends with notable exceptions, such as 2013, when the S&P 500 surged despite surging interest rates. Nevertheless, rising rates create a serious headwind going forward and eventually they tend to be discounted. As the yield on the 10 year Treasury approaches that of the earnings yield (1 over the PE), investors at the margin will prefer Treasuries to stocks, putting pressure on stock prices. In fact, whenever the earnings yield exceeds the 10 year Treasury yield by 4.2% or more, the market returns a whopping 33.9% annualized on average since 1953. Currently the earnings yield is 2.5% greater than the 10 year yield, putting it in the 75th to 90th percentile.
