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Four Scenarios for the Fourth Quarter


The next three months are shaping up to be crucial to the big picture.


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:


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:


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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No positions in stocks mentioned.

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