Stock market drop threatens to be 'the one'

Fibonacci Forecaster

Is this the one? That’s what traders want to know. They want to know if it’s the big one. I think they really want to know if it is this is the long anticipated correction we’ve been expecting.

Here’s my simple explanation. Several weeks ago a couple of talking heads on television said the market either needed a ‘normal’ correction or one that would drop about 3-5%. I didn’t know you can have it ‘your way.’ Since sentiment was getting so one-way lopsided, so complacent that having a correction would be a good thing, I started telling clients that when the correction did come, there wasn’t going to be anything ‘normal’ about it. When it hit, it would bite. Then it would hit on one of our time windows, which it did. For all the markets I follow, I would say that just about everything topped within a day or 2 or right on the button of our 144 day window off the low from last June.

The question of whether this ‘the one’ can be answered simply just by looking at this SPX chart. Just going back to June we have a near term connect the dots trend line break. There’s a bigger connect the dots line sitting just below 1750 and for now it’s just above the 200 day moving average. A really big one is going to break the 200. For now this is good enough to be the one we’ve been waiting for.

Click chart to enlarge

Here’s one of my big concerns. Before the top, I mentioned that for a correction to materialize the higher probability had to be a bigger, more aggressive move in the US Dollar. It was setting up for a bigger ABC based on the initial move off the low at the last Fed meeting. That has not materialized as for the most part the Greenback has been lower with equities and the surprise of the year thus far has been the inverse to equities move up in the precious metals. It’s extra strange because the consequence has been a EUR-USD move up with the stock market. When the stock market corrects we don’t normally see the currency in rally mode. It might just be a coincidence because the Euro or the Greenback might be in a larger sideways and we don’t know it yet. But if the Greenback were to continue dropping with equities eventually we’d end up with inflation or dare I say hyperinflationary problem.

Starting in 2008, it has been our view the economy could continue to slowly improve over time if the Dollar stayed in a trading range above the 72 low and below the 90 high. Those have more or less been the guide posts, even the 3rd rail to use a New York subway analogy. That outlook has played out very well over the past 5 years. I don’t think we are in danger of challenging that hypothesis right now but one does have to wonder how far this correction can go. What I really didn’t want to mention because the real market low is October 2011 is the fact the NDX did top at 616 trading days off its August 2011 bottom. Never mind the NASDAQ, Dow and SPX bottomed on October 4, not August 9. What that means is day 610 off the October bottom falls out on March 10 which is right in the 261 week window off the 09 bottom and it’s also the 14th anniversary of the end of the NASDAQ bubble. So the next window is huge. The problem is its still weeks away. Unless we get a quick end to this correction the way we did back in July/August 2007 before the final top, the good news is if we end up with a 6 week correction it will set up an incredible inversion low and a great rally for the rest of this year.

Do you remember 2007? It was almost a double top as the Russell 2000 ended up peaking in July, everything bottomed in August and the euphoria was back by the time we got the final high in October. There was a brutally quick correction before the final leg up which led to the really big one. So I’ll give our friends on television this one, a ‘normal’ market will give us a multiweek correction after the kind of rally we just had and then because I believe in the secular bull, an inversion low on a big time window would set up the next leg of the bull. I learned a long time ago the trend is your friend until it isn’t and this market hasn’t given me a reason not to believe in the bull for the past 5 years.

In terms of psychology we are not even close to being at the end of this move no matter how brutal Thursday and Friday looked. If you want to know what the end of a correction feels like, we need to not only get fear to build but also get the feeling the market is staying down for the count. Of all the news events that could have materialized, it turned out to be China PMI they picked on. Traders were only looking at China PMI data because they were looking for an excuse to sell. They were looking for an excuse to sell because time and the cycle expired. Had the same PMI data come out a week or 2 earlier traders likely would have overlooked it the way they overlooked every other piece of news for the past year. But the VIX was up on Friday because they are concerned with emerging market currencies. So now we have the element of fear entering the equation for the first time in a long time. The question we need to be asking is whether this correction will end with a VIX in the low 20’s or will it revert to a ‘normal’ correction where the VIX rises above 30? See, those of you looking for normal should be very careful about what you ask for. In fact the last time we had a real ‘normal’ nasty correction the VIX peaked not at 20, not even at 30! In August 2011 the VIX topped at 48! People have been awfully spoiled with the VIX topping in the low 20’s the way it did over the past year. Since we are only in the 18 handle that would mean we still have a long way to go.

Next page: The waiting game

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