Risk On is Almost Risk Off

The most important chart stock bulls want to keep a close eye on is the ratio of stocks to bonds. When rising, investors willing to accept risk, want to be heavily invested in stocks. When falling, bonds are the place to be as they are providing the best comparative returns.

As you can see, the ratio peaked in 2016 and in the process of changing character. Changing from an uptrend where higher highs and higher lows were the norm to one where lower highs and lower lows are occurring. All is not completely lost for stock bulls as the ratio is in a sideways consolidation and has held its key horizontal support level. Watch out though, if that level gives way that would be a strong argument it’s time to hunker down into less risky assets.

Some Targets

It’s a brutal market with no sign of let up (for now). Because of the spike in the VIX and large selling volume (when seen together are signs of a short-term bottom) a short-term rally is expected. But with algorithm and HFT trading and the BIG money away for the holidays, oversold can get more oversold which is exactly what we are seeing.

As investors we would all love to know when the decline will end but unfortunately, we will only know that in hindsight. What I have done is layered some technical analysis targets onto US index chart in an attempt to come up with downside pattern targets just for perspective. The bottom line is its highly likely the markets are not done falling.  

Targets for all chart indexes are labeled “T1”

Dow Jones Industrials

SP500 -

Nasdaq -

Small Caps -

It’s always good to remind everyone here, once again, that markets go up and down, not up or down. I expect we will get at least one more rally before we find a final bottom, whenever and wherever that turns out to be. When we do put in a final low, coming out of it will not be a straight path like the one down has been. Consolidation and basing will be required to rid the market of the remaining sellers before a new uptrend is established.

Keep in mind, the targets are nothing more than possibilities. In strong downtrends, markets tend to overshoot their targets so it would not be unexpected to find an end to this correction well below the pattern target. This is not a prediction but rather keeping our minds open to the possibilities to adjust our expectations.  Just so we are on the same page, what we want to see is a continued correction and the further the decline the better. No, I am not nuts.. This would set us up for a much more attractive future investment opportunity. The bigger the drop, the bigger the opportunity. Are you onboard?

The Importance of 100

I’ve spoken ad nauseum about the importance of areas of support and resistance. Scanning my charts there is no better example than the $100 price level on the biotech sector ETF, IBB. The more times price touches a level, the more important that level is. As you would expect, when price is underneath the level, it acts as resistance and when its above, it acts as support.  

The reason I bring it to your attention is that (as of now) it appears as if price has broken below. If you were a holder of IBB, you should very seriously consider exiting your position as the higher probabilities are for price to continue lower. The target for the decline is down at 2016 lows near $80, some 20% lower than where we start the day. Of course, since our timeframe is based upon weekly closes (and its only Tuesday when I am actually writing this post), for this target to be validated, we would need to see a close below this level at week’s end and immediately followed by a confirmation close the following week.

When there is a very clear support/resistance level, it makes your investment plan very simple. When above be long, when below, sell or go short.

I Hope I am Wrong

I am sure you don’t need my confirmation to know the markets have a bug up their rear.  Since peaking in October, the SP500 has declined almost 12% peak to trough and sits just above the February lows. That low should act as support if prices want to probe lower.  Notice how the initial breakdown from the Oct high was a 3 wave (a-b-c) decline on falling volume? Also, how the current push down is set up to be exactly the same? We just don’t know where wave c will end on this push. If symmetry is any gauge, a logical target for c to complete is around the “support zone”.

Because the market moves in waves (its internal structure), we know a reflexive bounce is likely due soon (this coming week?). Short term traders will take this opportunity to add risk while longer term investors will need to see where this next bounce higher ends. A failure to break above the initial b wave high, would be the time to consider exiting all stock positions by selling into strength. A move higher would target October’s (and all-time) highs as the next logical area for a move higher to stall.

Most large downward moves are in response to either news or poor investor sentiment, or both. Which is why, I am going to stand behind my 10-21-18 video of why I believe October’s highs will turn out to be the end of this almost 10-year bull market.  I hope I am wrong.

Looking Over the Ledge … For a Clue

Keeping with being their role as a canary in the proverbial coal mine, US small cap stocks continue to lead the broader market both into and out of corrections. This includes the most recent correction that started in the August-September timeframe. As you can see in their weekly chart below, the price of the small cap stock index, IWM, sits right on critical support. A breakdown below the $142-$143 level suggests another 17% decline is in the cards based upon a confirmed head and shoulders pattern target, T1.

Another possible outcome we need to consider is that the current level will actually hold support, move higher on to new highs and remain in a bull market uptrend.

Between the above two possible outcome, I think we will see lower prices in our short to intermediate term future (new lows). But the market doesnt care what I think. There is a version of the breakdown that I am actually favoring at this time. The right shoulder of the pattern is unsymmetrical and a bit malformed (stunted in its time of development) as compared to the left. This can occur in strong downward trending markets but it is not a ideal. As such, I could see the market chop around here a bit more before it resumes its move lower. This would allow the right shoulder to further develop before the breakdown and flush lower occurs. Either way this goes, it is currently at an interesting level. Either way this goes, it is currently at an interesting level and one that shouold interest both bulls and bears alike.