By: Fernando Gonzalez, EvolutionTrading.net
January 3, 2010
It’s that time of year to make grand assessments. In order to understand where the Equity Markets are at now, and discuss the possibilities of the future, let’s take a look back a little bit, before looking ahead: 2009 ended-up as the antithesis of 2008. If ’08 was a year that reminded us of just how fragile the financial markets and the economy can be, with a violent 50% loss of value, year ’09 reminds us just how stable these very same markets can become, by coming back and very steadily and solidly recovering 50% of the damage. Let’s take a quick look:
There was a lot to worry about coming into 2009 as you can see in the chart above, particularly when the first quarter of the year developed into a chilling 30% swan-dive further into the abyss and into an 11+ year low in the S&P500. Such a development in the Stock Market elicits a familiar sense of incredible uncertainty of the future – I say familiar, because it somewhat reminded us of the foreboding sentiment towards national security immediately following 9/11, except this time, it was “economic” or financial security.
And then came March 6, 2009 – “THE bottom” which happened to be right at the creepy devil’s number 666 in the S&P500. Little did most of us know that the market’s downward spiral would end there and stage an incredibly stable 70% rally by year’s end. For those of you that love Technical Analysis, the major LO established in March ’09 was yet another spectacular long-term gap closure event:
Did a technical gap closure “cause” a bottom? No way. It just happened to be the spot where many things lined-up, just like all other gap closures that produce major LO.
Now, how could everything “line-up” right in the middle of financial Armageddon? We were all watching the decline into the abyss, financial institutions falling like dominos, public officials hysterical on television, everyone seeming to blame the breakdown on one reason or another. We were all picturing images from the economic Armageddons of the past and preparing for lines for jobs, gas and food…
The 9-month rally that followed was a classic ascent up the “mountain of worry.” This is a mountain that the US equity market is no stranger to climbing for over a hundred years. When people are fearful of the Stock Market, everyone runs away, most people sell out or just stop buying. What we have remaining in the aftermath of a violent decline are participants that would rather bury their head in the sand than sell their holdings. These are tough hands, and their risk is enormous. Fortunately, the stock market remains open for business – and when you have tough hands – those refusing to sell, what you have is a lack of sellers. Eventually, the other tough hands arrive – those that have saved for the rainy day, those with the money, resources and can afford to come into a market that has declined. Now, there are not many of them, but when you have a situation where a market is open and operating with minimal selling, it structurally doesn’t take that much buying to launch the market UPwards, and “cause” a stabilizing effect.
In combination with the very heavily debated government intervention, (a debate we will not be engaging in today) what we eventually had in most of 2009 was a market that levitated to the tune of 70% higher from its lowest point. And so, the markets stabilized, and the retracement or “bounce” following the big decline of 2008 was underway. By the time all is said and done for 2009, the markets had found within it a path to reconstruct 50% of the prior damage. It took over 8 months, and it seems like it was a blink of an eye, and everything is ok again. This is what it seems, and in my opinion, this is where it is the hardest. Why? Because the market’s have hit an equilibrium.
EQUILIBRIUM. The DOW chart above goes back 16 years, and the last 2 months are magnified to show an area where the market has been confined for 8 weeks now, remaining in an extremely tight, and equally rare 2% range. It began on November 11th, and volatility has collapsed ever since. In previous newsletters, I referred to the area as the “epicenter” of the prior decline. While we view this halfway retracement as a matter of resistance, which it eventually turned out to be, what was incredibly surprising was how all the action seems to have ended there in the final 2 months of 2009.
The preceding rally which launched from 2 points: March and July 2009 felt much like the very same feeling one would get on a roller coaster that has just dropped and was once again climbing – can you imagine that clicking sound? In November that clicking sound stopped and our roller coaster has arrived at a long and flat plateau I can only describe – in financial market terms – as an equilibrium point, right smack at the epicenter of the great 2008 decline. Equilibrium is what they tell you in Finance class, and is really more of a theory than it is practical, as liquid markets are always in a state of constant change. It has been amazing to experience, in the last 8 weeks, as close as reality can arrive to that theory. Little did I know, as a Finance student in Boston College over 20 years ago, that I would actually experience seeing the US Equity Markets in such a state, but even less was the thought that follows: So, what now? I don’t recall ever discussing what comes after equilibrium. DIS-equilibrium, or MORE-equilibrium? This is what makes things difficult.
DILEMMA. Earlier, we mentioned that 2009 was the antithesis, the opposite of 2008. ’08 was a year of tremendous fragility, and immediately thereafter, ’09 brought a year of tremendous stability. As we look out to 2010, it is quite a dilemma as expecting movement to either direction is, in and of itself, a rather large risk. Over the many years as both trader and investor, forecasting the year was never really all that difficult for me. The tides were rather easy to read. 2010 presents a situation where at best I can expect a continuing oscillation that doesn’t stray far (perhaps 10%) from equilibrium point, even though the turn of the year is likely to bring in volatility (turns of the year have always brought that in).
There is one point, however, in August of 2010 that is noteworthy. There, we have a crossroads in time, as the time consumed from the all-time HI, down to the March 2009 is equaled. In the illustration below, I designate the approximate range at which the markets are contained within 10% from equilibrium (gray shaded area), and then we also label the August 2010, a point in time which puts a breakaway into play:
There is a reason for the larger red arrow above – that means that based upon the larger structure of the chart, we observe that the largest fastest most violent move in the entire period is still downwards, and that we remain within a time window (see blue arrows below) where that momentum holds greater dominance, and thus that direction has a greater probability.
As difficult and full of uncertainty and dilemmas the year 2010 begins with, we shall never know how it will end until we are already looking back at it in hindsight. After all, look at how 2009 began, and look at the dramatic turn of events by the time it ended. As is always the case, our future expectations are always in a state of “Evolution” – it’s the reason behind the name our name: Evolution Trading. The challenge is to not ever “stop the clock” or be “married” to an idea, but rather, carefully observe, adapt, evolve and as always: prepare to be surprised.
Best wishes for a blessed 2010.
