We have to realize that at every intermediate cycle decline (profit-taking), the media is going to find a reason for why the market is topping. The end of QE1, QE2, QE3, QE over with, raising interest rates, Brexit, Presidental election, North Korea, it just keeps going and going. There is a story behind every correction. Currently, it’s about the Fed raising interest rates more aggressively. History shows that initially, a rate hike is beneficial to the stock market.
Historically rates are very low, the 10-year treasury yield is still below 3%. These corrections are just profit taking events and have little to do with the news at the time of the correction.
There are certain types of cycle lows that are worth knowing about. A left translated cycle low is where most bear markets emerge. I know the terminology may be difficult for some of you, just follow along.
You’ll notice that the initial decline in September of 2015 was followed by a quick rally. This was followed by a decline below the previous decline in January of 2016. In this case, the decline became old news and the markets continued higher. Bear markets tend to start following this kind of cycle. Let’s look at a right translated cycle decline.
You’ll notice that the November decline was at a higher level than the July decline. Bear markets don’t top as a right translated cycle. So, what we are looking at is profit-taking. We probably started a parabolic phase in January.
We knew that we were going to have a correction, we just didn’t know when. I mentioned that possibility in December of last year. If you had moved out of the market in early January you would have missed out on a big market run-up. We are now in a correction phase and at some point, the correction will experience an exhaustion of selling pressure. Just before this current correction, I laid out some reasons to expect this decline and it did pan out. We reached some price objectives that I had been looking for and once those objectives were reached, a correction was a normal event to expect.
We should be looking at a bottom with a sharp move upwards, a V-shaped recovery. So, nothing unusual is happening. You’ll see a couple of shock and awe days that scare investors very quickly. The next cycle to the upside should even more aggressive.
How far will the markets retrace? A normal correction would take us to the 2700 area on the S&P 500 and we’re only halfway there. A couple of scenarios are possible. We could see the markets go immediately to 2700 and then rally to new highs. We could also see a rally on Monday and then move down to 2700. There is really nothing unusual going on, just a correction in a market that needed one.