It was a proverbial catastrophe in stock markets in the first week of 2016. Major markets across the globe lost between 6% and 10% , in a matter of 5 trading days. That has never happened before.
We do not anticipate a 2008/9 scenario right here, as our set of indicators is signaling extreme readings. Let’s revise where we stand, and conclude on what’s to come.
First, the S&P 500 from a chart perspective has reached the intersect of two important trendlines: the 2009 uptrend and the support line which connects the traditional end-of-year corrections over the last 3 years. The former is represented by the red line on the chart below, the latter by the purple line. We believe the sell off will find sufficient support between 1890 and 1910 points.
The transportation index (TRAN), as part of the Dow Jones Index, has reached long term support . The red dotted line on the next chart is representing a trend channel since the 2002 correction. The TRAN index topped withint that trend channel at the end of 2014, and only some 12 months later it has reached its support line. Moreover, the divergence with the crude oil price has reached extreme levels. Lower crude prices are supposed to support the transportation sector. Such a divergence can last for some time, but this situation seems really stretched.
Third, one of our favorite indicators is the bonds to stocks ratio, as seen on the next chart. The ratio has nicely been moving in a range since 2007. Although the apex of the triangle on the chart is not far away, we still think that the ongoing trend is intact. Look how the recent stock sell off resulted in a breakout of the triangle formation. A similar situation occured in 2012. If this formation is structurally broken, though, we would stocks to sell off in a big way, and bonds to rally strongly. With the U.S. Fed committed to rate interest hikes, at least in its guidance towards the market, we believe the likelihood of a big rally in bonds and a stock selloff to be rather small.
Fourth, the TED spread acting as the fear barometer has reached an area of extremes, at least in ‘normal’ times. We exclude a cataclysmic situation similar to 2008/9 when we mention ‘normal’. The TED spread , being in a clear uptrend, found resistance each time in the past it arrived at current levels.
Last, the bulls to bears ratio according to the latest AAII survey has also reached extreme levels. This is a sentiment indicator, and, as we know, sentiment is not a good timing tool.
When combining the data from our indicators above, we believe the stock market sell off is over for now. In the unlikely scenario that the decline will continue in the coming days, then a 2008/9 scenario is really in the cards.
Given the extreme readings of our indicators outlined above, combined with the support levels in the ongoing trends, we believe at least a relief rally is setting up in the very short term. The evolution of our indicators during the next rally should provide clues about the outlook for the coming months, not only for stocks but also for other markets.