That Escalated Quickly

It’s 4am on the West Coast. Markets looked shakey as I went to sleep. And for whatever reason, sleep just wasn’t happening. So at 3am I checked the futures markets. They’re suspended…

Well, since I’m not sleeping anyway, let’s take the time to dig into this thing a little more than a typical Monday (and yes, this is longer than typical – and probably more typos than typical – no apologies even).

So Sunday night into Monday in the wee hours of the morning, the futures markets were halted as European stocks tumbled and traders pushed the futures lower. And by lower, I mean… much lower. Like over 8% lower.

Apparently oil is collapsing. The details are coming in. But I don’t yet have all the pieces sorted out. It sounds like Saudi Arabia is engaging in some form of “price war” if headlines are to be believed (which I generally take with a grain of salt these days).

This puts the markets in a tough place. Essentially, whether it should be or not, the Covid-19 coronavirus has become a Black Swan Event. The fear of economic impact has changed behavior, thus creating the economic impact everyone fears.

History will discuss whether or not a reckless media drove the world toward panic, or whether this was, in fact, a justified reaction. But today, it’s neither useful nor practical to discuss these points. Instead, we must discuss what — if anything — there is to do as investors.

The challenge of this event is the speed at which it has gripped the markets. In essence, just 12 trading days ago, the S&P 500 was at all-time highs and markets were climbing higher. Then the coronavirus scare took hold. Since then we’ve seen a market route.

The S&P 500 (SPX) is down over 12 percent in 12 days. Based on overnight futures, it’s likely to drop another 4+ percent today. And it’s hard to know where the end is.

Don’t mistake this analysis as panic. It is not. This is merely observation of the behaviors of both the public and government reactions.

If the standard protocol for virus management is quarantine, this WILL have an economic impact on our global economy. Already we’re seeing cruise ships held out of port – travel restrictions – and runs on toilet paper and hand sanitizer. Now we’re seeing local governments declare states of emergency (Oregon joined the list yesterday). This is no longer an academic exercise. The impact is real.

Whether it is rational or not is not the point. It is happening.

The speed and timing of this event creates a challenge for the BigFoot algorithms. They are built on week-over-week moving indicators to avoid whip-saw trading. And all this activity has been compressed into essentially two weeks.

Currently, for the SPX and NASDAQ, the BigFoot trading algorithms have sell signals. For the DJIA, the algo’s still have a hold signal. But after this week, assuming the market route continues, we’ll likely see that signal flip to sell as well. We’ve also seen the overall disposition of the trading database fall to about 51% long. This is another 4% lower than last week’s 55%-ish reading. And we’re well off the low 80% long levels of just a month ago.

Why hasn’t it sold sooner? Because the markets have been on such an aggressive upward move for so long, it’s skewed all the comparative data the system uses to make trades.

The weird thing is, compared to two weeks ago, the markets look terrible. But compared to six months ago, we’re still about flat. That’s not that bad relatively speaking. The trading tools understand this. And they aren’t swayed by our emotions. They remain consistent and statistically driven. It is our own emotions we must beware of.

If one is to override the decisions of the system (not suggesting you do this), one must believe the conditions will deteriorate further. In essence, you must front-run the signals. And to do so is to break from the process, the statistics, and all the data to this point the system is relying on. Again, beware of allowing emotions to drive this process (as historically, investor emotions tend to create mistakes that cost).

Of course, no two markets are alike. Historically, corrections and bear markets each have their own unique circumstances that drive their outcomes. So historical statistics are but a guide here. Nevertheless, to override the signals is to introduce new and unpredictable variables into your investment process.

Of course, the big questions I suspect most are wondering is, when will the macro signals change (since they are all still long at this time)? And what do we think the markets may do?

First, the macros.

There are presently three marco indicators in the BigFoot system. Each looks at data from a different angle.

The market macro, not surprisingly, looks at market prices. It is a slow-moving indicator that can only change on a monthly basis. Currently, the signal is long, but will flip to sell if the SPX fails to close above 3160 at the end of March. As of right now, there appears to be a high probability this will occur.

The economic macro is a different animal. It follows a weekly signal, so can be more active than the market macro. It is built on a neural network that is constantly analyzing data to adapt. It will require more significant shifts in economic data before it flips to sell. This does not appear to be on the near-term horizon. Then again, data is moving quickly all the sudden.

The credit macro, like the economic macro, is a weekly signal. It uses a different artificial intelligence system to track key data points. In essence, it tracks risk in the credit system. If we see default rates on the rise, this indicator will likely flip as well. But for now, it appears stable.

So, in the near-term, it looks like the algo system is triggering a bunch of sells and holds — including the major indexes. But the macros remain long (at least for now). But we’re watching the market algo in anticipation it will fip at the end of the month.

Understanding how the algo’s and macro’s are viewing the data, this brings us to the discussion portion of our blog today: what are the market technicals telling us?

In short, this thing is ugly. The fall has been so rapid there is very little in the form of support. So now we look to big fat round numbers and emotional lines in the sand.

What does that mean? Well, the big fat round numbers are the ones that are easy to see on a chart… numbers that end in 0… like 3000, or 2900, or 2800… or 2650, as you’ll see in a minute.

And the emotional lines in the sand? Those are things like the 50, 100, or 200-day moving averages, or a 10% pull-back of 20% pull-back from a high value.

So far, the SPX is breaking down in all of these categories save one: the 20% pull-back. To investment professionals, this is the official bear market line in the sand. (And yes, this blog is being written with the idea that most who read it are pro’s, but some of you may not be – or some of your pro’s actually sent you here to read this so you can understand how we are analyzing things are attempting to keep logic and reason in the investment equation).

So what would be a legalistic bear market? A close below 2714.816 by my math.

So let’s talk numbers. The SPX closed at 2972.37 on Friday, March 6, 2020. Futures are down big. And we’re looking for the floor. Where might we find it?

Well, here are the key numbers as best I can tell:

2943 / 2911 / 2857 / 2772 / 2725 / 2681 / 2609 / 2407 / 2351

Based on the futures, we’re likely to blow past 2911 at the open today. So 2857/2850 will be the next line in the sand. But futures were halted at what looks more like 2819 or so. If that’s true, the markets may be testing the 2772 level shortly.

Bottom line, sellers outweigh buyers right now. Governments have stepped in to attempt to manage the spread of Covid-19, and economic activity is being affected. The follow-on effects are still yet unknown. But we know this: the up-trend has failed, and there is massive momentum to the downside right now. If the futures are right, there’s more pain to come.

This is just a guess, but based on the escalating fear, the bear market scenario looks pretty high. If we hit the extremes of the current downside targets, it would be a 30% correction from the peak. That’s rough… but it’s not 2008 rough. (Because when you lose 50% in an investment, you need 100% gain just to break even. When you lose 30%, you “only” need about a 43% recovery to break even. )

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