Why stocks and gold are about to reverse course

There’s a reason why commercial traders are regression to the mean traders. In this business it is the one thing that you can absolutely bank on. It's like death and taxes, it never fails. All markets eventually return to the mean. An appropriate corollary to this rule is that the further an asset gets stretched above or below the mean, the more violent the regression is, and the further it will move past the mean during the snapback.

You can see this clearly in the chart below.

Click to enlarge.

Notice that during the bull market from 2002-2007 the S&P never stretched extremely far above the 200 day moving average (well until the final euphoria phase in 2007). Consequently, each intermediate correction halted at or slightly below the 200-day moving average.

This changed when the new cyclical bull market started in 2009. It changed because the markets were not allowed to trade naturally. They were warped by massive doses of quantitative easing. This caused markets to stretch much further above the 200-day moving average than would have occurred normally. The consequences of course were that when the corrections hit they unwound violently and moved much further below the 200-DMA than would have occurred naturally. 

This bull market is much more volatile than the previous one because the market is being driven by currency debasement instead of true economic expansion. 

Now we are in a situation where the stock market has been stretched ridiculously far above the mean by QE 3 & 4. Trust me, Federal Reserve Chairman Ben Bernanke has not abolished the forces of regression to the mean. All he has done is guarantee that the regression is going to be many multiples more violent than it should have been.

When this house of cards topples over, I think there is a pretty good chance it’s going to be even more severe than what happened in 2011.

Also notice the red arrows marking major cyclical bull and bear market turning points. Notice the Fed warped the last cyclical bull market much higher and longer in duration than should have occurred naturally (he turned a four-year cycle into a 6-1/2-year cycle). Consequently the forces of regression responded by triggering the second worst bear market in history. The current cyclical bull market, although not stretched as long in time, is extremely stretched in magnitude so the resulting bear market will almost certainly be exceptionally violent and protracted.

comments powered by Disqus