Possible Scenarios

One of the most infamous sentiments in the investment arena is, “this time it’s different.”  Every major sell off in the history of publicly traded stock markets have elicited those sentiments from observers both amateur and professional.  While normal ebbs and flows can be reasonably explained in real time, when a big sigma selloff occurs, seemingly out of nowhere, it seems to stir the darkest fears of people about the future of markets.  There are those that insist that “we’re all going to die” but there are others who prefer to view it terms of, “ok, but when?”

It’s certainly true that markets reflect the collective condition of an economy, but a subset of that zeitgeist are intangible cultural, social and political considerations, much of which are unpredictable.  Of course, we can never know whether an event will be a world changing one such as occurred in 1914 when the Archduke Ferdinand was assassinated and precipitated the first world war….or whether the event is a an over reaction to a fixable glitch such as the Y2K fears rampant at the turn of this century. 

The present global response to the viral outbreak is definitely at Defcon 3 with all manner of economic and social activity shut down….worldwide, something not seen in history and more befitting of an alien invasion.  It’s true that the scale of fear is something few have ever seen before and who knows, maybe this time it is different.  But now that more information is being revealed as to the nature of the outbreak and possible resolutions, market participants can more rationally assess the possible scenarios for the eventual outcome as reflected by the markets. 

We’ve discussed the notion of trends many times and how their reference can help one navigate the ebbs and flows that invariably occur in markets.  In our present time, the longer that prices stay in this particular negative phase, the more likely that the once strongly advancing moving averages will statistically turn flat and necessitate revised tactics and strategies.  At this point, we don’t know.  Even wizened market “experts” differ on the path forward.

However, based on market behavior in the past we can anticipate a number of  scenarios which can be used to plan for some possible outcomes.  Undoubtedly, market psychology has been damaged, but even so, upside moves can be expected once peak hysteria abates.  In historical cases where similar selloffs have occurred, the path of subsequent market activity can follow a few identifiable trajectories.  One such pattern is the classic broadening formation which reflects confusion and uncertainty.  This can be illustrated by the monthly chart of the Dow Jones:

 

The chart shows the level of support in the chart above which was decisively pierced on the recent selloff in mid February. We also indicate the next likely price thresholds, which were the highs established years ago; those levels  now become support.  If this correction scenario unfolds, the anticipated bounce level labelled above can be anticipated to ascend to 3 possible fibonacci retracement levels for the Dow depending on the confidence of market participants. They are at 22,540 if a 38% retracement; 23,688 if a 50% retracement and up to the 24,833 level  if a full 62% of the recent selloff has enough optimism. 

The Dow could inflect at any of those levels, which would cause me to expect a resumption of the next leg down targeting a fall to the area of previous years’ support, also indicated in the chart.  To be clear, these are not predictions, they are expectations once certain thresholds are attained.  These expectations are useful for managing funds at possible inflection points and providing paths of action if necessary.  As we saw in early 2009, the Dow managed to resume a powerful uptrend after a steep sell off as well, so scenarios are just that.  We have to be prepared if in fact this time, it is different.

The assumption at this point is the area labelled ‘we are here’ holds in the next few trading sessions.  If not, then the path of the market may just move directly to the area labelled “previous resistance, now support”.  This is a scenario drawn from action in the long term monthly charts.  More precise activity on any possible inflection activity will be gleaned from the shorter term market momentum statistics that have been discussed previously; advance-declines, options premiums and such. However,  the longer term charts can provide a strategic plan by gauging scenarios not clear from the volatile action of shorter term swings.

 

 

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