Precarious Times for Equity Markets

By: Bob Loukas | Mon, Feb 2, 2015
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It suddenly seems as though the good times in equities might be ending. Though my perspective is based only on "gut feel", there seems to be an underlying level of fear that has crept into the markets. If so, it's a real problem for equities. Any market trading at all-time highs and with a valuation far above historical averages requires a continued level of irrational excitement and speculative ignorance to remain sustainable. And fear is not consistent with irrational, speculative ignorance.

When equities price in Risk, it can happen quickly, and I believe the markets are in the early stages of doing just that. Though equities don't want to believe that significant downside is possible, crashes in commodity prices and massive demand for high quality debt are harbingers of significant declines ahead. In my opinion, the early stages of an equity market decline are unfolding, and it's only a matter of time before it erupts into a serious event.

Macroeconomic measures don't always correlate directly with equity market performance, at least not in the immediate term. But when economic numbers begin to look as ugly as they are at present, I can assure you that an overheated and extended market will stand up and take notice. Of particular note this week are several ominous signs:

In quoting the above statistics, I'm mindful of the fact there are always both negative and positive points that an analyst can use to support a point of view. In this case, though, I honestly feel that the severity and depth of current macroeconomic developments are well outside of the norm. The extreme movements in many markets are interrelated, and seem to be a reflection of a rapidly deteriorating economic landscape.

These shifts are showing up as weakness in equity markets. As days tick by, and as the Daily Cycle Low (DCL) draws closer, the S&P has continued to knock against lower support areas. Throughout the past 3 year bull advance, at this point in the Cycle the S&P has pushed higher to new all-time highs. So the current position - bumping against support - is definitely a change in character, one that is telling us that the market may be exhausted. In my opinion, it is also telling us that 2015 is going to be a difficult period for markets. The current Daily Cycle (DC) has not failed yet, but it's sitting near the lows, and at this point, that's a very ominous development.

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From a Cycle standpoint, the equity markets are still showing higher highs and higher lows. So, following strict Cycle discipline, I could make the argument that the bull market is alive and well. And for this reason, we are forced to show it some respect. But the most surprising development from here would be for equities to roar higher. Such a move would catch many (yet again) by surprise, but I think it's unlikely this time.

The bull market has had its time, and the bears look like they will finally have a chance to control the action. With the 2nd DC looking ready to roll-over, and with numerous tests of the 26 week moving average in play, the market's change in character appears ready to play out in prices.

Severe downward pressure is obviously building, and at a point in the Investor Cycle (IC) where a continuing bull market should see us pushing to new highs. The technical indicators confirm that this is an Investor Cycle in its declining phase, and it would be very rare to have the Cycle suddenly change course at this point.

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Recent developments are, perhaps, most apparent on a monthly chart. With January's close, for the first time since the up-move began in 2011, we have a monthly candle that is entirely below the massive bull market channel. This alone is fairly strong evidence to support the idea that the market has topped.

The technical indicators paint a similar picture. The monthly RSI is showing diverging weakness, while the first negative monthly MACD cross since the 19%, 2011 decline is a serious warning sign. When we combine the negative technical indicators and macro-economic weakness with recent Daily Cycle struggles, and then consider them in the context of an overextended cyclical bull market, there's compelling evidence that the market is on the verge of a major decline.

If the current Daily Cycle fails in the coming weeks, it will set off a domino effect of cascading Cycle failures. A DC failure would almost certainly result in an IC failure with a move below 1,816. This would be, at a minimum, a deep Yearly Cycle decline by the early spring. From there, how deep equities might fall is really anybody's guess.

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Bob Loukas

Author: Bob Loukas

Bob Loukas
The Financial Tap

Bob Loukas is the founder of "The Financial Tap", a membership site dedicated to helping traders and investors navigate the markets while increasing their expertise and understanding. Bob has over 20 years of experience in trading the markets, is a life-long student of economics, and has an abiding passion for the financial markets. Much of his investment philosophy is top-down in nature, beginning with a global and macro outlook which is used to create a framework that drives his intermediate investments.

Bob is a leading expert in Market Cycles. His love of Cycles grew after his introduction to the work of Walter Bressert, one of the pioneers in the field. Cycles were a natural fit with Bob's passion for top-down analysis. As Cycles are intertwined on multiple time frames, understanding the global outlook greatly helps him to identify the long dated Secular Cycles. From that point Bob is better able to identify the shorter Cycles and to build a cohesive investment strategy. Bob's Cycle Analyzer, a software based analytical and intelligence system, is used to predict the future movements of the major financial markets.

Originally from Sydney, Australia, he is now settled and has been working in New York City for the past 13 years. His background and education is in Computer Sciences and he holds a bachelor's degree from Monash University in Melbourne Australia. He has extensive experience in the Financial Software area and has served as a senior executive at various Fortune 50 management teams developing financial trading and reporting software.

Happily married with two children, family is a big part of his everyday life. Other passions including golf and long distance running. He plans to complete the 2012 New York City marathon.

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