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Posted April 27, 2022

Sean Ring

By Sean Ring

Beware the Bearish Bots

  • The markets took a bath yesterday, erasing the Mondays gains and then some.
  • The Dow was down over 800 points (-2.38%); the Nazzie was down over 500 (-3.95%).
  • Weve got a Skynet problem: the bots will take it from here.

Happy Hump Day from a cool, sunny Piedmont.

Philosophers always concentrate on subjects theyre bad at.

I know one who lies whenever his lips move and then proceeds to write about truth.

Its hilarious.

Philosophers try to find the answers theyre looking for to correct their faults.

But the same may hold true in other areas.

For instance, Im an enormous Sherlockian.

Each time I read one of Doyles tales or watch Jeremy Brett play the great detective, Im as pleased with the case outcomes as a five-year-old watching a magician pull a rabbit out of his hat.

I realized thats because Im not an analyst in the pure sense of the word.

Perhaps I love Sherlock because hes excellent at deductive reasoning, and Im not.

How did I finally arrive at that conclusion?

My good friends Mark McGrath and Hunter Hastings co-wrote a paper for the Austrian Economics Research Conference held by the Mises Institute this past year.

You can listen to a great podcast they did together here.

Anytime I read something and a ding goes off in my head, I love it.

Mark and Hunter made my head go ding with the following passage about John Boyd, an American strategic theorist.

Boyd developed a theory of learning and understanding rooted in making effective decisions and taking rapid action.

Boyd describes two ways in which one can develop and manipulate mental concepts (orientation) to represent observed reality.

Those two ways are deductive reasoning and inductive reasoning.

Deductive reasoning is the analysis by which we break down a comprehensive whole into specific components.

For instance, thats what excellent analysts like JC Parets at allstarcharts.com (technical analysis), Lev Borodovsky at thedailyshot.com (fundamental analysis), and Andrew Pancholi at The Market Timing Report (sentiment and cycle analysis) do.

I read their work all the time, and it feeds the Rude.

I admire them like I admire Sherlock because their analysis is complicated, or at least unnatural, for me.

But Boyd talked about that all-important second part: inductive reasoning.

Inductive reasoning is the synthesis of those broken down parts (from deductive reasoning) into something novel that didnt previously exist.

In essence, Im taking the parts (say, stock market analysis) and constructing them into a new whole (my scribblings in the Rude every day).

And since the outcomes in the stock market are always uncertain, inductive reasoning is especially important for taking analysis and making decisions with it.

Anyway, sorry for the long introduction.

But today, I want to show you what Ive synthesized concerning market movements.

The SPX is in Trouble, But Not as Much as the Nasdaq

There are 73 Nasdaq companies in the S&P 500.

Thats plenty of overlap, so the indices tend to move together.

Not perfectly, of course!

But youll see how similar the charts are below.

Lets start with the SPX.

On the below chart, Ive lettered a few points from A to D:

To save time, Ill bullet point the story:

A. The SPX peak at the beginning of 2022.

B. After a roughly 12.5% drop, the SPX recovered, but not to the previous high.

C. After another 9% drop, the SPX recovered above B, giving investors reason to be bullish.

D. That optimism was short-lived, as the SPX has fallen nearly 10% since C.

The index now sits below its 50-day moving average (the blue line), and the 50-day MA sits below the 200-day MA (the red line).

Really not good.

The Nasdaq Composites chart looks eerily similar to the SPXs, but peaked earlier in November 2021.

But from the November peak to today, its a nearly 23% drop.

Conclusion: the tech market is uglier than a drunk carpenters thumb.

Let me head back to the SPX.

In this chart, we can see the SPX from 1990 to today.

Its a monthly chart with the 9-month moving average (roughly 200 days) overlaying the monthly candles.

I noted that the was plenty of time to get out before the bottom during the dot-com crash of 2000-2002.

How so?

Because the SPX was trading below that 9-month MA line for months before it finally troughed.

And though no one wants to admit it, there was a full six months of ugliness before the market bottomed out in March 2009.

Ive zoomed in on the chart here:

My point is that now were trading below the 9-month MA again.

There have been five times before when the index has been below the 9-month MA and recovered to make new highs.

But the key is that the Fed was either cutting or reversed hiking into cutting to avoid a colossal stock market sell-off.

Are we willing to bet Jay Powell takes off his Volcker mask to save the market a 6th time?

Im not, though Albert Edwards and Mohammed El-Erian disagree with me.

The Buffett Indicator

The Buffett Indicator measures the ratio of the stock market to GDP.

We use the Wilshire 5000 index as a proxy for the stock market.

The Wilshire 5000 is the index of all American stocks actively traded in the United States.

As you can see from the chart, the ratio peaked at much lower levels before the 2000 and 2008 crashes.

The Buffett Indicator

Credit: Longtermtrends.net

This time, what bothers me is not the heightened index level, but that its turned around and is heading down.

NYSE Percent of Stocks Above the 200-Day Moving Average

This indicator is a JC Parets favorite, and Ive shown it before.

JCs rule is this: dont own stocks when the ratio is below 15.

Thats the lighter line under the bright blue line.

I eyeballed the bright blue line.

I was looking for, At what point is a fall below 15 inevitable?

Though its not perfect, only one time did the indicator fall below 25.88, recover, and not hit 15.

That is, if we hit 26, were heading down. Hard.

Right now, the index sits at an uncomfortably low 32.

And fall isnt inevitable, but its highly likely

BTFD is Indeed Painful This Year

Two days ago, I wrote a piece titled BTFD is Suicidal For Your Portfolio.

Not only do I stand by it, but Lev Borodovsky over at The Daily Shot published this table from Bloomberg:

Source: The Daily Shot

If you wanted quantitative proof BTFD isnt a good strategy right now, here it is.

Wrap Up

Heres my synthesis: theres just too much going wrong.

And thats where my fear comes in: the bots know all.

Most trading is done by algorithm or electronically.

Its not brokers or investors hitting the buy and sell buttons.

The bots have their orders and may execute them in a way their coder - usually a hedge fund manager - didnt intend them to.

And that leads to gap risk.

The simple way to think of gap risk is that everyone is heading for the exits simultaneously.

And the price falls out of bed accordingly.

The chances of gap risk occurring on a large scale across asset classes increase daily.

Be careful out there.

Until tomorrow.

All the best,

Sean

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