Four Scenarios for the Fourth Quarter
I've been anxiously waiting for the fourth quarter to begin for months now because, based on the quarterly DeMark studies I follow, it will kick off a very unique inflection point across multiple global indexes.
There are four scenarios I'm looking at as possibilities, all providing some important long-term context to the market. Before we get to that, it's useful to look back and add some context to our present juncture. Below are this decade's returns for various global stock market indexes (since January 1, 2000):
- DJIA: -15.15%
- SPX: -27.8%
- CCMP: -47.9%
- FTSE100: -26.7%
- DAX: +18.8%
- NIKKEI: -39.4%
- HANG SENG: +24.2%
Annualize those and you'll see that even the two outlier winners -- DAX and Hang Seng -- are miserable performers for taking the risk of owning equities.
The reason to keep this in mind is because it highlights a very important point -- we've had a pretty severe global bear market in major stock indexes over the past 10 years. So the question is, what comes next?
Well, that's why I'm following the long-term quarterly charts with such interest. Just as bulls were ebullient at the top, trying to squeeze every last drop of gain out of the indexes, convinced in their herd-driven certitude we have likely reached a permanently high plateau, so too will bears at the bottom over-reach, convinced that the stock market will never again recapture old highs, dogmatic in the belief that some looming crisis will forever dampen equity indexes. Neither will be correct. The answer is always somewhere in between, and since I have no idea what that in-between answer will be, I'll look to the long-term DeMark charts to be a guide.
First, let's look at the long-term yearly chart of the S&P 500:
CLICK TO ENLARGE
Looking at this chart we can see that a TD Sequential sell signal recorded in 1998. After a TD Sequential signal records, the market is given 12 subsequent bars to react. And indeed, we've had a decent reaction, with next year completing the 12-bar window. Meanwhile, a setup in the opposite direction has begun to count, but it's very early in the setup, too early in fact to say if it will continue.
Given that we're exiting the 12-bar window next year, the door is open for lower time frames to become more dominant in their counts, which is why the quarterly charts in my mind are so important. A potential TD Buy Setup on the quarterly charts, combined with exiting the 12-bar window on the yearly charts, would tell me that bears have possibly wrung as much long-term risk out of the market as one could hope.
Notice, I said "long-term" risk. Short-term risk is, for most people, leveraged risk. Long-term risk is different. Since 1997, the best buying points have all come below 900 on the S&P 500. Yet, we're all programmed to believe that moves below 900 could quickly usher in something far worse... perhaps 450? More than a few economists and market thinkers I have great respect for believe 450 could be a reasonable downside target. We'll revisit that in a bit.
Moving on to the quarterly chart, let's look at where we stand as the fourth quarter approaches and what the potential scenarios are. The critical nature of the fourth quarter is that it will help identify how much downside risk there is for long-term equity positions. Again, I'll explain more about this in a bit.
Below is the quarterly chart of the S&P 500:
CLICK TO ENLARGE
A few things to notice here. I marked the prior TD setups. A buy setup in 2002 was an important turn, while the muted response to the sell setup in 2005 was an important warning (because setups typically produce a reaction in one to four bars) that upside momentum was strong enough to blow through it and continue the trend.
As well, note that the move above the dashed green line was a disqualified break in 2007 and that, so far, the move below the red TDST downside line is disqualified. A qualification of these lines is important because a setup that breaks a TDST line in a qualified manner is a warning that the setup will likely proceed to a full TD Sequential countdown. The fact that the TDST was not qualified in the downside break in late 2008 and early this year is at least one feather in the bulls' cap.
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so much in it, much of which i try to get a general handle on at least...
one that's re-appeared here and there in your posts, and that's become a recurring mental itch, is:
"...even for traders, the way I've chosen to contextualize these potential scenarios is to recognize that stocks are beginning to separate from the market, which is necessary for the eventual bottom to form...." -
thanks kevin!
Well done.
My question regarding your analysis and other technical analysis of the NUMBERS involved in technicals is this: how do you reconcile the equations with the shifting makeup of the underlying reality?
The market indices are stocks which are tied, in one way or another, to the realities of life.
If there is a disconnect from reality in the factors that underly stocks and markets, is there any validity to numerical projections utilizing past data?
For example: the housing bubble, and securitization bubbles, have been based on leveraging debt. The debts could not be paid when the over-leveraged value of homes collapsed. This leverage and these bubbles did not exist in previous years or decades that comprise large chunks of data from which analysts use to construct current assumptions and future predictions.
Therefore, future predictions are distorted by fundamental changes in the reality underlying stock prices and maket indices. Unless you have a metric to adjust for the this reality, the numbers and the predictions for the future become increasingly unreliable and simply speculative.
An analogy would be trying to predict my future performance running the mile based upon my previous performance, and without the knowldge that I have an endocrine disorder and a brain tumor.
If the past ten years of the markets were based on a debt bubble, and the moves in the market in the past six months based on deficit spending and FED liquidity and monetization of debt; of what value is the data in making any predictions of the future?
Thanks!
Eric
As lousy as the global stock market indexes have done so far this decade it should have been worse. On a daily, weekly, monthly or even yearly basis you can separate the markets from the economy but sooner or later reality must intervene. Your question should be, how did the markets do so terribly despite the huge amount of public and private debt incurred and despite the elixir of 401K contributions?
There are near term problems with a housing glut, a debt glut and rising unemployment. However, what people seem to be missing is that as we work through these issues other, much larger, problems are on their way. I can't over-estimate the affects of the baby boomers leaving their peak earnings years and drawing down their retirement accounts (instead of ctributing to them) will have on the markets. In my opinon the single most important element which explains the rise in stock prices since the 80s (beyond inflation) is the pervasiveness of 401K plans. Where would the markets be without these contributions?
Next, the housing glut will only get worse as baby boomers move into assisted living, demand more health resources and ultimately die off. How do we stimulate our way out of that issue?
Next, the other major contributor to our illusory prosperity was cheap energy. Beyond the simple answer of conservation, which Americans find abhorrent, all other roads lead to much more expensive energy and the decline in profits that will accompany it.
Next, the concept of a 'service economy' was a cruel hoax and we will need to spend trillions to rebuild our manufacturing base or face the consequneces of the developing countries getting stronger while we get weaker.
Analysis based on past rules is nonsense when the game has changed. This American 'can do' attitude that everyone seems to be relying on has no value if its directed toward easy 'fixes'. America is like a talented man who became a drug addict. If the future of our economy, our country and yes, the markets, is to be brighter we need to first kick our addiction to cheap credit, cheap energy and the foolish idea that we can prosper by skimming profits from the labors of the developing nations. Our only hope is to become a developing nation ourselves and 'out-develop' them.
Good question. The answer is, I don't. There are too many uncertainties and I'm not smart enough to be able to break down fundamental probabilities into how they will impact the market. I can understand how the economy functions and outline probably economic paths, but the market and the economy are two different things, and so I want to focus on the market when making investment and trading decisions and the economy when considering economic decisions.
I agree with you, the variancies in the fundamentals and the probabilities is likely more complex than global weather pattern forecasting.
I'm not criticizing your effort to make trading decisions, only cautioning (myself included) that the markets are tied to the economy like a dog on a leash. They may run ahead or lag behind, but the are dependent upon AN economy to function.
If the foundation of the economy has been undermined and shifted, the disconnect or distortion in reality between economy and markets is that much greater, and more dangerous.
My impression, looking back 50-100 years is that we are at an all time high of distortion between economic and market reality; at least since the 1930's. I see the same disconnect and distortion between the laws of nature and humanity's distance from them in terms of food and fiber production and the cycle of life.
I'm getting too big picture and waxing (waning) philosophic however.
On the trading short term side of life I would say buy Apple. I do I.T. support and I can tell you that Apple is on it's way to 40% market share of PC and smartphone sales, while already monopolizing the music markets.
I love your ' dog on a leash' metaphor for the connection between the economy and the markets!
However, you are dreaming if you think Apple will reach a 40% PC market share with their business model. This was already demonstarted in the Beta vs. VHS war. For Apple to beat out Microsoft, or Microsoft's replacement(s), they would need to license their technology...but then they wouldn't be Apple anymore. The very reason Apple computers are liked so much by their faithful followers is the very reason they will always be a niche company. Nothing wrong with that but once again we need to acknowledge reality.
Actually, the worst thing that could happen for the Apple true believers is for Apple computers to become mainstream because then they would be confronted by all of Microsoft's demons...viruses, quality control issues and the focus of competition that comes with being on top.
And you are exactly right about the demons; they have arisen as Apple market share has gone up because they become a bigger target exponentially for hackers.
I know what you mean about the proprietary nature of Apple as well, however, the younger generations are buying Apple for it's cache' as much as functionality. Price does not seem to be an issue. Apple also recently introduced "Snow Leopard" operating system for $29.
Windows Vista has been an utter disaster. Windows 7 may help repair the damage, but I see the pendulum of perception swinging in Apple's favor. If Apple decides to support generic hardware, Microsoft is in for BIG trouble. Hackers already run Mac OS on generic equipment. The move from the Power PC (proprietary Motorola and IBM processors and chipsets) ended a number of years ago and Mac's now use Intel processors and chipsets identical to Windows or Linux PC's.
I'm not an Apple person, just commenting on what I am observing the user base doing.
To tie this back into Kevin's scenario's, I would say that Apple stock may be an indicator; although whether it will be a leader, laggard, or concurrent one is anybody's guess.
Your article and all of the above discussion has been running around my head for the last few weeks.
I have noted that many of the old heads that traditionally post have been relatively quite in my mind and your article has put many of our thoughts to print. Clarifying that the market and the economy are clearly operating on separate pages and may have done for decades in my mind has been amplified with this crisis. I feel lucky to have been around to see this picture so clearly demonstrated as odd as this may sound.
I have always invested from a longer term profile and this has allowed me to bet against the market / logic a couple of times thanks to reading the Ville and coupled with only luck in hindsight.
As an unsophisticated trader I continue to look to the long term but the article you have posted today still leaves me on the side lines at this point and perhaps for another 24 months. There is little value, to my mind in the markets I trade and the current instability is not conducive to a Nancy like myself. After reading as much as I am able my gut tells me something has to give either financially or as Toddo often states geopolitically.
Comments posted mentioning 401k's and other vehicles of this nature globally in my mind are having their hay day in the markets now but moving forward I have my doubts whether this is sustainable and logically should impact the market over time (I am not a fan of such vehicles' as they are fundamentally flawed in my view.) . Glad I am not operating a large performance based fund at this point in time. Thanks for writings mate it's all good.
Best regards
Pete
Just a little bit to learn in this game. It's very cool of you to be willing to share your own misstep as a lesson to us and a reinforcement of devising and sticking to some clear rules.
If you want a fair comparison, you have to take off all dividends payed from 2000.
In short, I don't know what the heck you are Todd are talking about!!!!
I pick stocks by researching balance sheets and pure gut instinct. So fa,r I have done well. Except, I don't know what to do, when this irrational beast you call a market goes red except to sell!! I did that in June much to my dismay.
What am I an idiot doing here? TD sent me over, Now, I am going home.
( I can't be alone out here, there has to be others...that are lost.)
Kevin, dear heart, are you doing yourself or any of us favors by being so erudite and complex that you may one day put your pants on backwards and wonder what went wrong? So many of your observations in various articles are excellent, but your tendency to the "on the one hand, on the other" scenarios, in attempting to see all sides of issues, can lead to "tharn" (seizure in the face of decisions) - a dire emotional situation I know too well. Thanks anyway.
The prevalent economic fantasy guiding modern global civilization is the fantasy that all of humanity can realistically aspire to a standard of living that, from a historical perspective, is a vertical spike highly localized to a tiny minority of humanity. Modern economic theory is a mathematical fantasy that has totally failed to model the coupling of economic activity to planetary systems that maintain the habitability of the planet. To skip to the conclusion, it is a complete fantasy that over six thousand million human beings can achieve a 1st world standard of living without totally trashing the climatological, oceanic and terrestrial ecosystems that make the planet habitable. It is, in fact, a complete fantasy that the existing 1st world can persist in the standard of living it achieved on a world with barely over 2B people when it now shares the planet with a rapidly growing population of over 6B+ people. In the pursuit of a fantasy, people are simply dismantling the systems that literally make life possible.
In a nutshell, there is vastly more fantasy 'wealth' in fiat currencies now than there is physical planet to provide goods and services commensurate with that wealth. The only real force in the financial markets at this point is the desperate attempt to convert 'fantasy' wealth in to real, sustainable wealth that will survive the inevitable collapse of a global economic system based on fiat currencies.
I'm heavy into commodities, gold and carefully selected land in benign climates where self sustaining food production is a possibility. At some point, one of these downturns is not going to have a bottom. Governments will no longer be able to feed and shelter their unemployed populations by printing money. People do not politely and quietly starve to death. Borders will be overrun and multiculturalism will degenerate into ethnic Balkanization.
As our fantasy based economic system collapses there is going to be massive civil unrest without historical precedent. Not tomorrow, not next year, but within the lifetimes of many reading this. Pray for your children and grandchildren. Prepare as best you can. Good luck to all.
