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    FEELING A CHILL ARE WE? THE VOLATILITY HAS ARRIVED!

    Here is a quote from last week’s update. These are the required steps in the “Big Chill” warning, when overly euphoric and aggressive investors/traders in large size suddenly feel a “big chill go down their spine”, when a break in the market causes them to recognize they are too exposed, often too leveraged, to equities. This recognition results in euphoric recklessness quickly becoming prudent sobriety, as they attempt to adjust their asset allocations away from equities, usually all at the same time. The stock market is driven by the perceptions and the discounting of the future, so when the generally accepted perception of a continuing bull market changes toward a more uncertain future, the elements for a nasty decline, or budding bear market start to build momentum.

    On February 12th  the popular stock indexes hit all-time highs while a host of supply and demand indicators were moving lower after weeks of displaying negative divergences. Fast forward a few days, and the indexes have moved into correction territory in the fewest number of days ever, and accelerating the decline in the TATY strategic supply and demand indicator, crashing it completely through the caution zone into the green zone surrounding the 90-100 level. TATY finished the week at 95, something it has only done on a monthly closing basis four times previously since the summer of 1998 Long Term Capital debacle. However, on an intraday basis the green zone surrounding the 90-100 level has been touched twelve times previously during the same time period, so Friday’s excursion into the green zone is number thirteen since the 1990s. The fourth chart above, snapshot 330, shows all the spikes into the green zone beginning from 1996, a period rich in history related to important stock market declines, hence the example. I apologize that the chart is so busy, but getting the perspective on one page may be helpful to seeing what is really happening.

    PANDEMIC! SARS, H2N2 FLU and EBOLA, how many of you remember what happened to the stock market in the aftermath of the media hype about these recent pandemic scares? Coronavirus is a problem, more severe than the run of the mill flu for sure, but certainly not on the level of Ebola, or the Black Plague of old, or more recently in the United States Small Pox, which thankfully is now confined for research purposes to a freezer at the CDC in Atlanta. Please remember news and facts do NOT drive the price of stocks, but rather it is the perceptions about future events. Given the tendency of the news cycle to be quite short these days, one must wonder how long the current pandemic scare will dominate the news, and by the way there is a rather important primary election next Tuesday, so soon there will be some serious competition for air time, just saying. OK that is enough of probably useless observations about current events, so let’s now turn our attention to some objective and more useful information, because it is information being generated by the market itself.

    In the strategic and tactical sections to follow, I will review the current state of the market, and provide some historical perspective on the history made this past week, as the popular indexes posted record point losses from record highs. Record point losses from record highs is not as an important metric as record percentage losses. The percentage losses from the record high were in the range of 3% per day, more or less. Some of us were plotting the market by hand on October 19, 1987, when the stock market declined a bit less than 25% in one day! These things happen in markets, fortunately not often, so let’s take a look at how to not only deal with these relatively rare events, but hopefully make money for clients in the process.

    TATY   —   A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS

    TATY is shown above in the first chart in yellow with the S&P-500 overlaid in red and blue candle chart format. TATY finished the week at 95 in the green zone surrounding the 90-100 level after falling through the caution zone surrounding the 115 level without pausing. This presents a bit of a conundrum, because declines into the caution zone surrounding the 115 level always trigger the first step in the process of eventually issuing a “Big Chill” warning. However, since the 1990s crashes into the green zone surrounding the 90-100 level have been followed by substantial rallies in bear markets, or rallies back to new all-time highs in bull markets. A TATY crash into the green zone suggests panic is causing a burn rate with would be sellers at such a high intensity that a tradable bottom may tend to form more quickly than usual.

    Please take a look at what has actually happened in the past (second Chart), when TATY declined into to green zone surrounding the 90-100 level, shown in the fourth chart above snapshot 330. The 1997 episode was a warning that investors and traders may be getting a bit uncomfortable as the market was touching new highs during the tech mania. The 1998 spike into the green zone was blamed on the collapse of Long Term Capital. The 1999 decline occurred as tech IPOs were coming to market and some of those companies did not even have any sales let alone earnings. The 2001-2003 bear market was blamed on 911, but that was a Red Herring, since the bear market was already well underway before 911. Sharp eyed investors will take notice that the events of September 2001 did result in a TATY excursion into the green zone, but the 2002 decline was actually more intense, and by the time the price touched its final low in March 2003 TATY had been rallying strongly for weeks.

    The 2007-2009 decline was blamed on the mortgage crisis, over-leveraged banks, and the collapse of Bear Sterns and Lehman Brothers. And, then there was the Flash Crash of May 2010, for which there was never a reason given that I remember, nor for the weakness in 2011, but there were some concerns that the recovery from the Great Recession may give out of gas. The 2015 weakness was thought to be the beginning of a new bear market, but the price decline, although painful, clocked in at only 16%, short of the commonly accepted bear threshold of 20% or more. The February 5, 2018 dip was related to difficulties by Credit Swiss to lay off its risks in the futures and options markets for its XIV volatility product. Credit Swiss ceased trading in the product, and investors trading the XIV took a hit. The late 2018 decline has been blamed by some as an echo of the earlier February issues with managing volatility risks. That brings us up to this past week, and the fifth excursion into the green zone on a monthly closing basis, and thirteenth overall intraday since the 1990s.

    The common denominator in all these cases is the spike into the green zone was a signal that sellers may be becoming exhausted, and the actual recovery back into the caution zone surrounding the 115 level was evidence the correction, or bear market, had likely ended a phase, or perhaps ended completely, and the recovery in the price was about to get underway, or had already started. Obviously, the premium/discount indicator, shown in the lower panel of the TATY chart, plunged below the minus eight level, and as it began to recover back toward minus three, then toward zero, the price was approaching its final lows, or had already made bottom, and had embarked on a bear market rally, or the next leg higher in a bull trend. Keep in mind that the chart is in monthly format in order to show the entire post 1996 period on one chart, because this time period contains some of the most important post WWII declines. TATY is usually shown only in weekly format, so what may appear to have been a quick process on the monthly chart actually unfolded over a period of days, or weeks. Please keep in mind that this is a historical perspective, and does not guarantee the current situation will develop in the same manner, but the odds suggest it likely will.

    The chart directly above is a weekly chart of the S&P-500, which shows how quickly all those small steps higher in a bull trend can be quickly erased in a correction. We religiously buy for clients only when we are offered a discount to value, and this chart is a vivid example of why, as it shows the rally from last fall has now been completely wiped out in record brevity. The last chart above is of the S&P-500 in monthly chart format, and I’ve overlaid a Fibonacci grid showing that the rally from the late 2018 low has now been retraced by 50%, a likely level from which a bounce may develop, or perhaps after some testing of a lower low, the development of a longer lasting rally attempt?

    However, history suggests that TATY must recover at least into the caution zone surrounding the 115 level, and the premium/discount indicator in the lower panel must turn up, and then rally back toward first the red line at minus eight, then on to the green line at minus three before the price will likely turn higher. So at the moment all we know for sure is motivated sellers are selling at a rate, which history suggests may be unsustainable, and causing exhaustion to arrive sooner rather than later. Should evidence of exhausted sellers appear, quickly followed by evidence of resurging demand, then we will become aggressive buyers in the expectation of a tradable rebound in a new bear market, or a resumption of the previous bull trend. Regardless of the “causes” for these previous panic like declines, the recoveries to date have all followed the same format according to our proprietary supply and demand indicators.

    SAMMY   —   A REPRESENTATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS

    SAMMY is shown above alone, and below with the SPXL 3X leveraged S&P-500 ETF overlaid. The SPXL is for reference only

    SAMMY has plunged with the market, but will become an extremely important indicator when buyers return in size to scoop up perceived bargains, after sellers have exhausted their propensity to sell. SAMMY is shown for information only in this update.

    THE BOTTOM LINE

    The S&P-500 eMini futures closed on December 31, 2019 at 3232 and change. I have been doing some limited dollar cost average buying in accounts with excess cash, as the price declined below S&P eMini 3232 level. I will begin to buy in size should our proprietary supply and demand indicators signal evidence that sellers have exhausted their propensity to sell, and evidence also arrives of re-surging demand. It matters not to us if we have entered the initial phase of a new bear market, or this is just a less than 20% correction in a continuing bull trend. I watched today as the S&P-500 eMini futures contract moved ten handles (points), or $500, in one minute! Volatility is the ally of those with the requisite analytical tools, training, experience and courage to turn the volatility, and price velocity to advantage.

    Corrections and/or bear markets are often like foundations for buildings. A shallow foundation being dug by workers with shovels will likely support a new one story building. A foundation being dug by multiple large excavators many feet deep will likely support a sky scraper yet to be constructed. In like manner, declines in the TATY strategic supply and demand indicator often tend to be foundations for the degree of the price recovery/rally to follow.

    Once we are provided objective information to become buyers at a discount to value, we shall hold newly purchased positions in anticipation of a significant, and tradable counter-trend rally in a new minted bear market, or a resumption of the previous bull trend. It is too soon to know which option the stock market will dial up. We are prepared for either.

     

    DISCLAIMER : Optimist Capital LLC, does not guarantee the accuracy and completeness of this report, nor is any liability assumed for any loss that may result from reliance by any person upon such information. The information and opinions contained herein are subject to change without notice and are for general information only. The data used for this report is from sources deemed to be reliable, but is not guaranteed for accuracy. Past performance is not a guide or guarantee of future performance. Optimist Capital LLC, and any third-party data providers, shall not have any liability for any loss sustained by anyone who relied on this publication’s contents, which is provided “as is.” Optimist Capital LLC disclaim any and all express or implied warranties, including, but not limited to, any warranties of merchantability, suitability or fitness for a particular purpose or use. Our data and opinions may not be updated as views or information change. Using any graph, chart, formula or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such device. The information contained in this report may not be published, broadcast, re-written, or otherwise distributed without prior written consent from Optimist Capital LLC.

    ByOptimist Capital

    Optimist Capital Institutional Wealth Management for All

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