Post Crash Behavior Leading to Dow 20,000

The day before Flash Crash II last week, I opined that the bottoming process could begin as early as last week. From my seat, it did. One week removed from the mini crash or crashette and stocks took it hard on the chin again. China was blamed, but that’s only a cover story and coincidence. However, unlike August 24, we did not see another Flash Crash. There was no panic. The selling was fairly orderly, which can be viewed as a good thing and a not so good thing. Volume was on the light side. Market internals were abhorrent.

In short, stocks are shaking out from mini crash type action according to history. Of all the declines since the bull market launched in 2009, including the 20% one in 2011, the current correction gives the bears the most ammunition to claim that a new bear market has started. But before you jump to conclusions, read on…

I remain steadfast that while the bull market may continue to be old, wrinkly and not exactly the pillar of health, it is nonetheless alive. That’s the same conclusion I have drawn during each and every decline since 2010. The final peak lies ahead of us and that’s very likely to be north of 20,000 on the Dow.

I know. I know. I am crazy.

Who in their right mind would forecast fresh all-time highs ahead, let alone Dow 20,000 with China imploding and global recession supposedly all but a certainty. And there is always a risk I am wrong, but I do love being in a camp by myself!

So getting back to the action since August 24, you can see a few different ways in light green arrows on the chart below on how this bottoming action may play out. I chose those paths by looking at other similar action. There weren’t many over the past 30 years where a bull market peak was so close. That was criteria number one. The bull market peak was within two months of the crash.

Defining the actual crash isn’t as easy. It’s easy to spot in hindsight and you can certainly feel it when it’s happening. It’s rapid downside acceleration without any intervening rallies that usually leads to a 3%+ down day at the end.

I am going to take you through each occurrence to compare and contrast starting with the most recent. The years will be listed on each chart along with the “crash”, one of the most overused words in investing lexicon, and then where the final bottom was before stocks took off again to the upside.

On the surface, 2011 and 2015 look very similar although the decline in 2011 was more damaging and deeper. It took roughly six weeks to bottom.

2010 is next. That’s where we saw the first Flash Crash which doesn’t seem all that bad on the surface. This week’s action looks very similar to the three day rally immediately after the Flash Crash. The final bottom was eight weeks later and at prices significantly below the crash, something very unusual.

1998 is next and that looks exactly like what we saw in 2011. In fact, I wrote an article after the crash in 2011 forecasting that the final bottom would be a mirror image of the 1998 decline. In both instances, the decline was more than 20% and the final bottom was six weeks after the crash.

1997 is below and that crash behavior doesn’t really behave like the rest. Stocks pulled back a little, but the crash was essentially a one day decline that was sharply reversed the very next day.

1994 is next and while the decline was not even 10%, the post crash action was very similar to most other periods. I marked the final bottom 11 weeks later because that was low from which stocks finally rallied, but you can certainly argue that it was right at the day of the crash.

1989 has some similarities to 1997 in that it was essentially a one day outlier decline based on the leveraged buyout craze imploding with takeovers in United and American Airlines falling apart with Donald Trump involved. The bottoming process was fairly quick and not very painful with the final bottom occurring roughly four weeks later.

Finally, the greatest crash of the modern investing era was seen in 1987. Similar to 9/11, most people remember where they were and what they thought as the day unfolded. I recall my father launching a new discount brokerage business that very day. While I thought the timing could not have been worse, he often said that it was perfect since none of his clients lost any money on that day as there were no clients yet!

As with most of the other crash periods, the final bottom was seen some weeks later, six in this case.

Crashes, mini crashes, crashettes are all very emotional events. The most panic is typically seen during the crash when the market makes its internal or momentum low. There is usually a rally and subsequent final bottom some weeks later. The only caveat I will add is that the more pervasive the sentiment towards this behavior, the more the market will morph and confound the masses.

As always, please do not hesitate to contact me directly by hitting reply to this email or by calling the office at 203.389.3553.

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Flash Crash II – HFT and Computers Run Amok… AGAIN

Well that was certainly fun on Monday! Stocks crashed 1100 points at the open, rallied 800 points and the fell almost 300 points to close down 588 points. Given yesterday’s full Street$marts edition and the two blog posts I did here, I am sure most people were expecting a market update. After all, I did offer 3 Scenarios for Monday’s Trading and the market did end up following scenario number one the most. I will get to the market in a subsequent post. Of note, almost every single interview I saw and comment I read called for “staying the course” or not selling. I guess those were the same folks who told investors that all was well over the previous few months as the major indices peaked. Hmmm…

It’s not a topic I often mention, but from my seat, the system was clearly broken in the first half hour and the computers ran amock. It was beyond embarrassing and ridiculous, AGAIN. Just like we saw in May 2010, this was a second Flash Crash. NYSE and NASDAQ? Goldman Sachs, Citadel, Merrill Lynch and Virtu? You can hear crickets from the cats who ate the canary.

As someone who had forecast and was positioned for the correction, I was chomping at the bit to deploy some cash. Without any widespread firsthand knowledge, I believe that High Frequency Trading or HFT was responsible, not for the whole stock market decline, but for the quick acceleration and pricing dislocations or anomalies. Remember, HFT thrives when markets are volatile and liquid. Not so much in quiet and less volatile markets.

What I did see firsthand was enough small orders of less than 100 shares early in the day to make me believe that the computers were out of control as one of the footprints of HFT is odd lot trading or orders less than 100 shares. Let’s add in the outrageous pricing in the opening few minutes that went away quickly enough that I couldn’t even finish getting my orders in the que to execute. A little sour grapes perhaps? Absolutely, but there was also something very wrong with our markets.

As the day began and I was glued to my screen, I noticed that XLV, a healthcare ETF was in free fall, showing an opening loss of 6% which almost immediately became 20%. These are not high flying micro cap technology stocks that don’t trade volume. These are the most liquid stocks in the healthcare field. Johnson & Johnson and Pfizer account for almost 18% of the ETF. Memories of May 2010 and the Flash Crash immediately came to mind. I quickly checked IBB, a biotech ETF, and saw similar but not as dramatic weakness. That was clue number two as biotech is almost always more volatile than XLV and should have been down more.


You can see what I am talking about in the chart above. XLV opened down 6% and quickly collapsed to down 26% at the bottom of the green candle right after the tall red one. Minutes later, XLV was trading at $69 or 20% higher. That’s not only abnormal, but shows a system not functioning like it was supposed to. And during this brief period as you can see above, volume was enormous, another hallmark of HFT.

I started looking at random large cap individual stocks both in and outside the healthcare sector and saw some truly astounding pricing dislocations in my opinion. Again, these stocks should not have fallen 20% in a matter of a few minutes. None had company specific bad news. GE, JP Morgan, CVS, McKesson and Verizon to name a few. I have not done a lot more research since then because I don’t think it’s worth the effort at this point, but I know from speaking with colleagues and peers that it was widespread in the ETF space. Just look at VHT, also in the healthcare space, below.


I am not big crier of injustice and “demander” of government intervention to fix our problems, so you won’t find me flooding the SEC with calls and emails or creating a grassroots campaign to do so. I won’t be surprised, however, if the SEC does open a formal inquiry into Monday’s opening of trading as another Flash Crash did occur. While my clients may have lost an opportunity, there were thousands of investors who were likely stopped out of their positions when they should not have been, costing them untold amounts of money.

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