Market Outlook: Is This A V-Shaped Recovery?

The stock market bounced this week after it tanked last week on trade war news. Is the stock market making a V-shaped recovery? Probably not.

  1. Technicals (short term, next 1-3 months): mixed. If I had to assign a probability to a V-shaped recovery, it would be < 40%
  2. Technicals (medium term, next 6-9 months): mostly bullish
  3. Fundamentals (long term): no significant U.S. macro deterioration, but the long term risk:reward doesn’t favor bulls.

Technicals: Short Term & Medium Term

*For reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

6% corrections

Traders usually define “corrections” as S&P declines that exceed 10%. I usually define them as declines that exceed 6%, because most 6%+ declines have at least 2 DOWN waves.

*I’m not a big fan of “waves” because there is no clear way to define a “wave”, but there is some validity to this concept.

The current decline has only seen 1 wave, which suggests that there is more selling ahead. Here are some examples from this bull market.

Here’s the S&P from 2018-present

Here’s the S&P from 2015-2016 (we exclude 2017 because there was no correction that year).

Here’s the S&P from 2013-2014

Here’s the S&P from 2011-2012

Here’s the S&P from 2009-2010

In this bull market, 11 corrections have seen multi-waves and 3 have been V-shaped. This ratio holds true in previous bull markets as well (e.g. 2003-2007, pre-2000). If I was forced to assign a specific probability to another DOWN leg, I would probably say probably 2/3

But keep in mind that the short term is always very hard to predict, no matter how much confidence you have in your predictive ability. Too many unpredictable events impact the short term. The news-driven environment doesn’t help either.

Patterns

The stock market reversed this week, forming something akin to a “hammer” pattern. This kind of weekly reversal pattern occurred during the first leg of other market selloffs.

When this happened in the past, the S&P often made lower lows over the next 2 weeks. The following table looks at what happened next to the S&P when the weekly LOW is more than -3% below last week’s LOW (i.e. intraweek plunge), but this week’s CLOSE is above last week’s LOW (recovery later in the week).

S&P was weak over the next 2 months.

Gold

This was a volatile week for markets. While stocks tanked, bonds and gold rallied in the face of extremely optimistic sentiment. As a result, the S&P:gold ratio plunged more than -9% over the past 2 weeks.

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Comments

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Moon Kil Woong 1 year ago Contributor's comment

There is a lot of negative news to digest and the market is taking it pretty well. That said, there is only so much the market can bear with unpredictability reigning supreme thanks to political factors that seem to be sliding out of control with no firm strategy. It is fortunate the Republicans and Democrats got a stimulus budget in before the recent set of issues.

Bill Johnson 1 year ago Member's comment

Very true.