I tend to shy away from the standard annual predictions we see take place during the first week of the new year. There are a variety of reasons but the main one is that my work does not lend itself to such long-term views. However, last year on the first day of the new year I did say that I thought 2018 would bring us a rise in volatility.
I looked like I was clueless as the month of January saw a steady melt higher in stocks and volatility went down but then volatility did lift itself from the ashes and has mostly been with us throughout 2018. And now it seems we see calls for a higher level of volatility everywhere we turn. I see recency bias is still hard at work in markets; human nature rarely changes.
I do think it is unlikely we are going back to significantly lower levels of volatility but that is not a terribly insightful call to make right now, is it? What I do think would be helpful to do right now is take a look at what markets have tended to do when we've seen so many extremes as we have had lately.
There is one common theme among almost all my indicators: the extremes we saw heading into Christmas are unusual and none have come at true bottoms. In almost every single case, no matter which indicator we look at, we have always seen more downside after the initial oversold rally and extreme indicator readings.
I have stated several times in 2018, beginning in the spring, that some of the indicators I follow had not been that oversold since previous bear markets. For example, when we take the spread between the 50- and 200-day moving average lines of the DJIA and plot the daily net change (meaning how far apart the two moving average lines are and how wide they move each day) we see it rarely gets down to -40.
Point A on the chart is the summer of 2002, when most markets made a low. We rallied and came down to a lower low in October. That is point B on the chart. Notice there was no extreme reading at the "real low." That's what we call a positive divergence, when the indexes make a lower low but the indicators behind them do not.
Notice that even the October low was not really the end of the selling; rather we came back down in March 2003 one more time. It is a long process. Not a short, fast one and those of us who like instant gratification are rarely rewarded during this process.
Point C is October 2008. Point D is March 2009. So here again, the lower low (in March 2009) for the indexes is barely noteworthy on the indicator chart.
Now look at Point E. That is the spring reading I refer to above. This past week we once again revisited it, something other lows have not done. No matter, what it tells us is that whatever rally we get off this recent low is likely to come back down again.
Take a look at the 10-day moving average of the number of stocks making new lows. We'll use Nasdaq. Point A shows up in the fall of 2001. That's the peak reading. Point B shows up at the October 2002 low. And by the time the low that launches the new bull market arrives, in March 2003, at point C the 10-day moving average is significantly lower than the previous two readings.
The 2008 bear market was no different. Notice the points A, B and C are successively lower highs on the indicator and lower lows for Nasdaq, the index.
There are many other indicators that all say the same thing so I won't run you through them, but you can see the theme is the same: extreme readings in the indicators give way to a rally that then gives way to another push down. That next leg down is either a successful retest or more of the same from the initial decline.
Finally, I would like to note that for now there are some interesting levels and lines on the charts of some of the major indexes. For example, look at the DJ Transportation index. The top it broke down from (just over 10,000) measured to 8700. Monday, December 24th, the Transports tagged 8636 on an intraday basis. Not only that, you have to admit this is one heckuva long term uptrend line it bounced from.
The S&P has a measured target around 2,300 which is where that line comes in. The low (so far) was 2351.
The Russell 2000's top measures to around 1,150-1,190 (depending on how thick your pencil is) and it got to 1266 so there is probably some unfinished business there. However that blue line represents some good support.
What we have is indicators that got extreme and we bounced (finally). We have indexes that met some measured targets or bounced off support. But the common theme for all these indicators is that extremes get retested. Whether or not those tests are successful remains to be seen. A successful test is when the indicators do not get as extreme as the previous reading. I expect 2019 will see retests.