{"id":46578,"date":"2018-12-25T23:24:48","date_gmt":"2018-12-26T07:24:48","guid":{"rendered":"https:\/\/drduru.com\/onetwentytwo\/?p=46578"},"modified":"2019-01-06T12:04:57","modified_gmt":"2019-01-06T20:04:57","slug":"t2108-update-181224","status":"publish","type":"post","link":"https:\/\/drduru.com\/onetwentytwo\/2018\/12\/25\/t2108-update-181224\/","title":{"rendered":"Above the 40 (December 24, 2018) – Oversold Chronicles: An Epic Reversal, Historic Depths, and an End to Hubris"},"content":{"rendered":"\n

AT40<\/strong> = 3.6% of stocks are trading above their respective 40-day moving averages (DMAs) (oversold day #7, 10-year low!)
AT200<\/strong> = 8.0% of stocks are trading above their respective 200DMAs (9 1\/2- year low!)
VIX<\/strong> = 36.1 (1-day gain of 20.0%, 10 1\/2- month high)
Short-term Trading Call<\/strong>: bullish (oh so many caveats below!)<\/p>\n\n\n\n

Commentary<\/strong>
<\/p>\n\n\n\n

Although it’s been said many times, many ways….the plunge continues….no Santa Claus rally for us.<\/p>\n\n\n\n

In a day and month full of historic extremes, it is hard to pick any particular focus of calamity. Still, the epic reversal in small caps, iShares Russell 2000 ETF (IWM), stands out in stark relief. On Christmas Eve, just as we should be expecting gifts from Treasury Secretary Steven “Santa Claus” Mnuchin’s modern incarnation of the Plunge Protection Team<\/a>, IWM officially reversed ALL of its 2016 breakout. The weekly chart below shows how little time it took to wipe out what was almost two years of breathtaking upside.<\/p>\n\n\n\n

\"The
The iShares Russell 2000 ETF (IWM) officially reversed all the gains from its late 2016 breakout. A complete reversal of post-election gains is not much further away.<\/figcaption><\/figure><\/div>\n\n\n\n

The market sell-off is so extreme that my favorite technical indicator, AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), has had little else to say beyond the first day of this jarring oversold period<\/a>. AT40 closed the day before Christmas at 3.6%; almost no stock in the entire stock market currently trades above its 40DMA. AT40 last traded this low in October, 2008 as the financial crisis was picking up steam. Before that chaotic period, I have to go back to the crash of 1987 to see AT40 plumb such epic depths. In the short-term, the stock market is completely washed out of any optimism.<\/p>\n\n\n\n

\"AT40
AT40 (T2108) is at rock bottom levels sitting at just 3.6%.<\/figcaption><\/figure><\/div>\n\n\n\n

There are almost no stocks left trading above their respective 200DMAs either. AT200 (T2107) closed at 7.8%, a 9 1\/2 year low. Since the October sell-off, AT200 has consistently flagged deepening technical damage in the stock market; now AT200 just confirms and reconfirms the stock market is deep in bear market territory. This is a market where breakdowns and lengthening downtrends dominate the storyline.<\/p>\n\n\n\n

\"AT200
AT200 (T2107) dropped into single-digits and a 9 1\/2 -year low.<\/figcaption><\/figure><\/div>\n\n\n\n

All the major indices sold off sharply going into Christmas. The shortened pre-holiday trading provided no relief. Not only was this the worst loss ever for the last trading day before Christmas, but also the S&P 500 had never before lost more than 1% on this day<\/a>. The S&P 500 (SPY) dropped and did not stop until it lost 2.7%. The index is now down an incredible 15.8% month-to-date for December (the worst December since 1951 was a 9.4% loss in 1980) and down 12.1% for the year. For perspective, the index has suffered only two losing years since 2008’s gut-wrenching 38.5% loss. Those losing years were fractional losses in 2011 and 2015. We have truly been spoiled by the Federal Reserve’s easy money policies.<\/p>\n\n\n\n

\"The
The S&P 500 (SPY) lost another 2.6% and closed at a 20-month low.<\/figcaption><\/figure><\/div>\n\n\n\n

Ironically enough, after the stock market quickly wiped out its post-election (2018) euphoria last month, I wrote the following<\/a>:<\/p>\n\n\n\n

I am quite dismayed to note that the S&P 500 has sold off in the immediate wake of all but two of the Fed\u2019s meetings this year\u2026.guess what I will be doing in preparation for December\u2019s meeting!?<\/p><\/blockquote>\n\n\n\n

I did not position myself bearishly because by the time of the Fed meeting, the stock market was already deep in the throes of its third oversold day<\/a>. Deeply oversold conditions offer poor risk\/reward short trades. Yet, the S&P 500 has amazingly managed to lose another 6.2% in the three trading days since the Fed’s decision on monetary policy. This is a second derivative market<\/a> if there ever was one!<\/p>\n\n\n\n

The NASDAQ and the Invesco QQQ Trust (QQQ) sold off for 2.2% and 2.8% losses and new 17 and 15-month lows respectively. <\/p>\n\n\n\n

\"The
The NASDAQ lost 2.2% and closed at a 17-month low.<\/figcaption><\/figure><\/div>\n\n\n\n
\"The
The Invesco QQQ Trust (QQQ) lost 2.2% and closed at a 15-month low.<\/figcaption><\/figure><\/div>\n\n\n\n

The sickening plunges are repeated over and over almost no matter where we look. The iShares Russell 2000 ETF (IWM) lost 1.9% for a 25-month low. The Financial Select Sector SPDR ETF (XLF) lost 2.1% for its own 25-month low (Goldman Sachs (GS) last week completed a post-election (2016) reversal and is leading the way for the entire XLF to do the same). The iShares US Home Construction ETF (ITB), which tried to warn us for much of the year of the coming calamity, lost another 2.0% and closed near a complete reversal of 2017’s gains. Even Health Care Select Sector SPDR ETF (XLV) got hit with a 2.4% loss as its roof of “safety” came tumbling down.<\/p>\n\n\n\n

\"The
The iShares Russell 2000 ETF (IWM) lost 1.9% and closed at a 25-month low.<\/figcaption><\/figure><\/div>\n\n\n\n
\"The
The Financial Select Sector SPDR ETF (XLF) lost 2.1% and closed at a 25-month low.<\/figcaption><\/figure><\/div>\n\n\n\n
\"The
The iShares US Home Construction ETF (ITB) lost another 2.0% and is on its way to finish reversing all its 2017 gains.<\/figcaption><\/figure><\/div>\n\n\n\n
\"The
The formerly “safe” Health Care Select Sector SPDR ETF (XLV) lost another 2.4% and is now challenging its 2018 lows.<\/figcaption><\/figure><\/div>\n\n\n\n

In my last Above the 40<\/a>, I described the volatility index, the VIX, as a “bright” spot for the oversold period because it finally showed a relatively greater level of fear. That fear really got going on Monday. The VIX surged 19.8% in a long overdue challenge of the closing high of 2018. With the 2012 intraday high behind it, the VIX can now aim for even higher heights of extremes. <\/p>\n\n\n\n

\"The
The volatility index, the VIX, has shown a lot more life in recent days. The VIX gained 19.8% almost closed at a new 2018 high.<\/figcaption><\/figure><\/div>\n\n\n\n

All this epic carnage and the historic depths beg the obvious question: is this a time to buy? Well, it SHOULD be an obvious<\/strong> time to back up the truck. My short-term trading call has stayed bullish ever since the first day of the oversold period<\/a>. I was waiting for the VIX to spike before getting aggressive on the buy side. On Friday, I finally added to my shares of ProShares Ultra S&P500 (SSO). I did a little more buying in the middle of Monday’s even larger VIX spike. For example, I saw some key stocks burst into positive territory, and I responded by buying a few put options on ProShares Ultra VIX Short-Term Futures (UVXY).
<\/p>\n\n\n\n

Still, I have yet to get truly aggressive because I cannot fully shake the demotivating burdens of a bear market: no support, only fleeting signs of buying interest. Moreover, I have a working thesis in the back of my mind that pattern matches with the 2008-2009 period<\/a> where the Fall sell-off was the setup for the even larger Winter sell-off. I want<\/strong> to believe the major January to March or so sell-off I am anticipating is getting condensed into December.<\/p>\n\n\n\n

From the longer-term perspective, I never did unload any more of my longer-term positions after the first purge about two weeks ago. With almost all my hedges closed out, I get to watch this treacherous trading action in horror along with the majority of market watchers. Hardier long-term investors can start allocating a small fraction of cash here, like 20%, and then allocate in chunks of 10% for every additional 10% sell-off (I am borrowing from a strategy someone shared with me on StockTwits). This strategy should<\/strong> cover the worst of the worst sell-off scenarios.<\/p>\n\n\n\n

However, in a second derivative market, the possibility horizon is very broad. Using the history of “the 200DMA Signal<\/a>,” the theoretical worst case scenario is the 0.15 “warning ratio” from 2007 to March, 2013: an eventual 63% sell-off from 2018’s all-time high. Yes, I just gulped hard after typing that. The current warning ratio is 0.47 as the S&P 500 is currently 19.8% off its all-time high. This is the 10th worst of the 19 200DMA Signals since 1951.<\/p>\n\n\n\n

\"The
The latest 200DMA Signal triggered on 10\/24\/18. The downdraft from the all-time high just missed the apparently critical negative 10-13% range.<\/figcaption><\/figure><\/div>\n\n\n\n

The Post-Trump Reversal<\/strong><\/h4>\n\n\n\n

This sell-off is so epic and so deep, it deserves a name that can immediately and easily identify it. I am now calling it the “Post-Trump Reversal.” The phrase “post-election” is too ambiguous. “Post-2016-election” or “post-election-2016” is too clumsy and does not fixate on a prime characteristic of this particular market. This reversal has wiped away a large portion of the stock market’s gains since the election of Donald Trump as President of the United States on November 8, 2016. In some cases, all gains and then some are gone. Just as ITB warned us almost all year of a coming calamity, Goldman Sachs, XLF, and IWM are all up next as big warnings of what could be in store for the rest of the stock market relative to the election of Trump. I am taking these warnings seriously: the market has to prove a LOT otherwise from here!<\/p>\n\n\n\n

\"The
The S&P 500 (SPY) slammed into its 200-week moving average. The big run-up to the January high has only weak supports until the point of the 2016 breakout.<\/figcaption><\/figure><\/div>\n\n\n\n
\"The
The NASDAQ is still above its uptrending 200-week moving average. A test coincides with 6000 and one of the few supports remaining on the way to a potential post-election reversal.<\/figcaption><\/figure><\/div>\n\n\n\n

As traders and investors, we should focus on making money over making political points. I try to follow this guidance in this blog as much as possible, but sometimes, like now, the politics become unavoidable. In this case, President Trump has inserted himself into the center of the trials, tribulations, and celebrations of the stock market. He personally forged the market into his own gauge of popularity and performance. Trump’s market commentary in total is quite revealing about the fragility of financial conditions, and it provides important context. As full disclosure, I am not registered with any political party (I am a former Democrat), but I voted against Trump and for Hillary Clinton for President in 2016. I hope I have sufficiently kept my politics from distracting from my most important points below.<\/p>\n\n\n\n

In mid-October, the stock market was in the early stages of its complete breakdown. I read and heard the exuberant platitudes coming from the administration over the economy and worried that the government was reaching a point of maximum hubris.<\/p>\n\n\n\n

…Larry Kudlow, the leader of President Trump\u2019s National Economic Council, is beating a steady drum of unapologetic and triumphant confidence. In a CNBC interview, Kudlow issued a sound bite that *I* am confident will one day in the not-so-distant future sound cringeworthy to those of us who follow economics. Kudlow declared: \u201cWe are in a hot economic boom. There\u2019s no end in sight.\u201d<\/p>

…as an investor and particularly as a trader, I cannot help but think about the contrary implications of important government officials claiming that the economic good times will continue as far as the eye can see. Such claims defy experience and the laws of economic\/business cycles. Such claims help form a foundation of hubris which can lead to policy errors. My unavoidable wariness feels even more poignant when in parallel I stare at charts showing a stock market violently and sharply falling off its all-time highs.<\/p>From “Confidence and A Conditional Reprieve Amid Oversold Lows<\/a>” by Dr. Duru, October 13, 2018.<\/cite><\/blockquote>\n\n\n\n

I only wish I had heeded my own wariness and just determined to go bearish and stay bearish! What unfolded in the following 2+ months pretty much confirmed my concerns. The final confirmation will come in the form of worsening economic numbers in 2019 that I am sure the administration (and the Fed?) will at first dismiss as “air pockets” or “temporary headwinds.” Note well that the economy need not go into a recession for the stock market to continue deflating given the stellar run-up was predicated on the kinds of lofty optimism expressed by Kudlow. Even now, consumer confidence is still hovering around 20-year highs. There is a lot of room to the downside to go to just more “normal” levels of confidence.<\/p>\n\n\n\n

The hubris and the subsequent repudiation of that hubris is summed up well in the following tweet and commentary from CNBC’s Carl Quintanilla.<\/p>\n\n\n\n

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Since this tweet, the S&P is down 18.9%. pic.twitter.com\/ICCr8oEruP<\/a><\/p>— Carl Quintanilla (@carlquintanilla) December 24, 2018<\/a><\/blockquote>