Wednesday, April 02, 2014

Stock Market at Another Key Juncture

Happy Birthday Bull! Equities At Another Key Juncture

By Dr Van Tharp Trading Education Institute

The equities bull market just passed its fifth anniversary this month. The low on March 6, 2009 seems like it was ages ago. Despite what has felt like a relentless bull run for five years, equities have actually seen five separate pullbacks of 10% since March, 2009. To be fair, however, three of those pullbacks occurred in close proximity during the second half of 2011.

When was the most recent 10% pullback? It came in the May–June drop of 2012. We’d have to go back to October of 2011 to find the last 10% close-to-close drop in the markets — which also followed two other 10% pullbacks. These came after the August 2011 U.S. debt rating downgrade and during the height of turmoil for the European credit crisis.

Why is a ten percent pullback so significant and talked about so often? That is the depth of pullback required to be considered a correction by market technicians. The purpose of this article is to give some insight into our current market situation. Let’s dig into the history of 10% pullbacks over the past 65 years and then look at some technical analysis that will give us some key areas to look for when we break out from this short-term congestion area.

A History of Ten Percent Pullbacks

Let’s start by looking at some excellent charts that give us a visual history of ten percent pullbacks. The first looks at the S&P 500 between 1950 and 1970:

This twenty-year period showed an average of about 20 months between the trough of a ten percent pullback and the peak that marked the high before the next correction. Moving forward to the 1980s and 1990s, we see some similarities but also some differences:

Here we see once again, there were only nine corrections in those two decades, but the trough-to-peak durations diverged widely in length. The 84-month period in the ‘90s and the three-plus year run leading up to the 1987 Black Monday crash skewed the average bull run duration but the median for this time period was less than a year.

As most readers remember, the volatility of the market has changed since 2000 and we have had multiple ten percent corrections. The majority of those have come in clusters; seven occurred during the 2000–2003 internet bubble collapse, followed by zero in the period from March 2003–October 2009. The real estate / credit bubble drop contained at least five corrections of ten percent, and we’ve had another five since the March 2009 bottom. So we’ve already had 17 corrections in the 13 years since 2000!

Why even look at these historical numbers? Because it’s useful to see how this bull compares to others. If you only count corrections on a closing basis, then our last ten percent close-to-close drop ended in October of 2011, making this bull push 17 months old.

So even though the bull is aging, there is certainly precedent that suggests that it could grow much older without setting any records…

Current Lines in the Sand

The chart below of the S&P 500 can tell us a lot in just one look:

As the chart shows, when we draw Fibonacci extensions based on the January five percent pullback, we see that our current double top in the S&P 500 cash index has the 127% extension as its cap or resistance zone. A decisive break above those highs should lead to a fairly quick run up the 161% extension level at 1920.

On the other hand, the 1840 level has been a key reaction zone since the end of last year. A break below that level brings 1800 into play followed by the lows set in early February at around 1740. Keep these key levels in mind when we break out of the current 1850–1880 congestion area.

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