It’s Just Time Former British Prime Minister Margaret Thatcher
(This article was originally published on 23rd June, then 08th September 2016 and later updated after the predicted early stage sell-off in equity markets after each of those timing windows.)
US equities sold off sharply on the opening week of September, during Friday 9th, with large cap markets such as the Dow, S&P500 & NASDAQ, breaking back under their previous all-time highs (ATHs) at 18351, 2135 and 4816 respectively. This served as a classic bearish volatility breakoutÂ (Fig 1), with the market previously exhibiting an unusual “calm before the storm” of almost 60 trading days without a 5% move up or down. In price terms, a number of markets also triggered “DeMark” exhaustion signals, which still suggests further downside pressure ahead. These market risks are further heightened against the backdrop of rising volatility (VIX).
Figure 1: US Equity market bearish volatility breakout & key trigger levels.
Source: RW Market Advisory, Market Analyst
Why now? It’s just time. One technical piece of the puzzle can be found in the annual cycles of each year which can bring a marked change not only to the weather but also the surrounding investment landscape. As the temperatures cool again in the fast approaching Autumn equinox (22nd September), our seasonality analysis suggests a growing probability for equity markets, notably those with the highest valuations, to be at risk of a major fall in the (autumn) fall of 2016, during late September/early October.
In fact, what the infamous market almanacs have long cited as the seasonal pattern of “Sell-in-May-and-Go-Away” or SIM, actually suffers its greatest downside risk during the months of June and September (Fig 2). The exact reasons for this general seasonal trading pattern are not known. Although, lower trading volumes due to the summer vacation months and increased investment flows during the winter months are traditionally highlighted as the discrepancy in the performance of the overall SIM period between May-October.
Figure 2: SIM Seasonality pattern suffers greatest downside risk in June & September.
Source: RW Market Advisory, Market Analyst
Looking back at this year, the equity markets did partly follow the early stages of this pattern by triggering a sharp correction during the second half of June (approx. -5%), which was further pressured by the mounting event risk of “Brexit”. However, US equity markets launched a sharp relief-rally from oversold conditions, into a marginal new all-time high (ATH) territory. This price reaction was also in-line with the expected timing window of the mid-summer rally, which tends to appear during the month of July (Fig 1.0). Thereafter, the probabilities favoured a market peak/drawdown process in the month of August.
Mr. Market should now lead us into the well-known “Autumn (Q3) Fall-Crash cycle” that traditionally unfolds between September and October. Figure 2a illustrates the shape of this seasonal pattern, which is based on the average performance of over 100 years of back-tested price data on the Dow Jones Industrial Average. These results tell us the largest price fall can be expected in late September, followed by a volatile rise/whipsaw, then another fall in October, which traditionally marks the final capitulation “true low” in the market.
Figure 3: Peak in late August-early September, with fall-crash cycle in Q3.Source: The ECU Group, Multi-Asset Research & Advisory Team, Datastream.
During the latest cyclical recovery since 2009, there have several peak/drawdown periods in August (Fig 4). The largest one occurred beforehand, on 8th August 2008, which marked one of the final major peaks of the Global Financial Crisis, triggering a drop of -34%. The second largest was an extended drawdown timing window into early August 2011, with a net fall of -17%, which triggered a week earlier on 22nd July.
More recently, our analysis had correctly predicted the mini-crash of 2015, which suffered a price drop of -14% during the month of August, pressured by the Chinese equity market crash. Historically, one of the most infamous seasonal anniversaries of this kind was the peak of the 25th August 1987, and we all know how that ended.
Figure 4: SIM Seasonality analysis bearish for (Autumn) fall.Source: RW Market Advisory, Market Analyst
Ultimately, this peak out in seasonality, not only marks the end of the shorter-term mid-summer-rally, but also a multitude of more powerful and larger cycles. This analysis is primarily based on Robin Griffiths’ signature Roadmap cycle schema, which is driven by a 10, 4 and 1-year cycle. The most influential input is the 10-year cycle, also known as the or decennial cycle, which according to our studies, has led to nine out of eleven of the major stock market corrections in the last 100 years (Fig 5). Two of the major corrections were in years ending ‘0’, and the remaining majority in years ending “7”.
Equity markets traditionally suffer their biggest drop in year 6-7 of the decade, which presently translates to 2016-2017. Here, we should also be alerted to the historically overextended nature of the market, having just broken the pre-2008 crisis record for a number of days without a 20% correction.
Figure 5: Cyclical market forces led to 9 out of 11 of major stock market corrections in the last 100 years (decennial & presidential cycles).
The 4-year presidential election cycle serves as an intermediate overlay, and this year is no exception with level of sheer political uncertainty ahead of the coming US elections in November, less than 60 days away.
Although, it is true that in the run-up to a US presidential election the market normally rises and stays strong through the election to give whoever wins a honeymoon period. However, if the election is at the end of a two-term president, they become a “lame duck”, thereby leading to a negative equity market underperformance of -13.8 % (Fig 6b). This occurs as the incumbent president runs out of time, with a lack of policy ammunition and in most cases diminishing popularity.
This year’s level of political and economic uncertainty is mounting higher with a rather polarized selection of US presidential candidates between Trump and Clinton. Market risks are further amplified by the ever widening divergence of asset price inflation vs. economic business conditions, ahead of a pending risk of Fed rate hikes (potentially on 20-21st September) and a looming Italian referendum that is set to trigger further ammunition at EU unity. Against this unique backdrop of event risk, the triad of aforementioned cycles; decennial, presidential and seasonal, all support our bearish roadmap prediction.
Figure 6: Presidential & Seasonal cycles, bearish projected roadmap (Q3 2016)Source: The ECU Group, Multi-Asset Research & Advisory Team, Datastream.
So far, the successful prediction was to begin the year with a negative January, which was one of the worst in over a decade, followed by a very strong rally from mid-February, into a mid-April peak and a sharp move down into late-June. There is now growing probability for the infamous Autumn fall-crash cycle of September and October; just one month ahead of the ever heated US presidential elections.
Technically speaking, it remains important to monitor the key equity market price confirmation for real evidence of trend direction. Only a move above the following risk levels at 4945 (NASDAQ Composite), 2203/20 (S&P500) and 18668 (Dow Jones Industrial) would either delay the timing, or alternatively a strong all-time high (ATH) breakout (signs of a new bull-trend extension, marked by a lower swing low above the ATH), would cancel the bearish perspective.
Until then, both price and time overlays continue to signal that bearish forces are clawing away at thisÂ â€œgreater foolâ€ danger zone, where the risk/reward remains highly asymmetric. The recovery from 2009 is still historically overstretched having already risen by 188% in over 89 months. A resulting bear skew will likely be much stronger this time around. Indeed, to quote an adapted market maxim “the stronger the market trend, the harder the price fall”. It should come as no surprise that when the Wall Street Bear starts its stampede, investors from around the world will be able to be feel the herded exit out of the stadium doors.
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By Ron William, CMT,
MSTA Founder & Principal Market Strategist
RW Market Advisory (RWA)