Post Mini Crash Stock Market Playbook. All-Time Highs Around the Corner

The Dow Jones Industrial Average “crashed” 666 points on Friday, at least that’s how the media portrayed it. And it’s on track to open another 1%+ lower this morning. In 1987, 666 points would have been more than 25%. In 2018, that’s all of 2.5%. 2.5% moves used to mostly occur monthly and certainly quarterly. During extreme periods of volatility, like 2001, 2002, 2008, 2009 and 2011, a 2.5% move would barely get noticed. Today, it’s BREAKING NEWS.


Recent volatility. For 24 months, stocks have been in their least volatile period of all-time. In 2008, investors got used to these outsized moves. In fact, we even saw a 10% move in a single day. Today that would be more than 2500 Dow points. However, since February 2016, the stock market hasn’t even declined 5% which will end this morning. And it’s been the longest streak in history without even a 3% decline.

So Friday’s mini crash (in points not percent) is somewhat of an outlier, a number that doesn’t really fit in the normal range of daily returns. More importantly, it occurred from new all-time highs five days earlier. Please re-read that sentence as declines like this do not typically happen so close to all-time highs. The chart below shows you what’s happening with the subsequent ones indicating a theme.

The next chart below is my favorite and one that I think is the best rhyme. It’s from 2007 when stocks collapsed at the end of February due to China’s market plummeting. The reasons do not matter. I repeat. The reasons for these declines are of absolutely no significance.

In 2007 stocks made an all-time high and then saw a mini crash five days later. Stock market internals were very strong before the decline. In math terms, it was a five sigma or standard deviation event. In other words it was a huge decline relative to the normal price behavior over the past year, just like today.

While the mini crash wasn’t the absolute bottom, it was pretty much most of the price damage. Stocks saw a short-term low a few days later, rallied and revisited that low shortly thereafter. And then stocks soared higher again.

Remember that.

In 1994 as you can see below, stocks were at all-time highs and saw a mini crash four days later from a period of very low volatility. But that was just the beginning of a larger decline and more challenging period.

Why show this? Was anything different?

There was a significant difference. In 1994 stock market internals were poor and had been deteriorating for months. The January 1994 peak was accompanied by a wide ranging group of divergences or non-confirmations. The market’s foundation was already crumbling, very much the opposite of today.

1991 is next and as with the previous charts, we have an all-time high followed by a mini-crash two weeks later. Market internals were strong before the decline. The ultimate low took a little longer, but the results were still the same. Stocks bottomed and then soared to new all-time highs.

1989 is the final comparison and although my data provider clearly has some incomplete data, I think you can get the gist of it. Stock market all-time high, mini crash a week later, rally, revisit and then stocks soar to all-time highs.

See the theme yet?

Markets never exactly repeat, but they certainly rhyme. Below you can see what I drew in as the scenario I see as most favored or likely at this point. Stocks are not done going down and they should continue lower early this week. A low should be formed, followed by a bounce of one to three weeks before the decline to the ultimate low takes place.

The key is not that the Dow exactly follows my arrows, but that once the low is in, stocks soar again. Yes, stocks soar again to fresh all-time highs and the bull market remains intact. The bull market is not over. This decline could speed up its ultimate fate, like it did in 2007, but that’s way too early to state right now.

Besides valuation, which is a horrible timing tool and sentiment which was certainly euphoric but can be corrected with this mini crash, stocks have done nothing wrong to indicate the bull market is over or even close to ending. Ignore the hysteria and focus on reality. Buying weakness remains the correct strategy until proven otherwise.

Assuming today is the volatile affair it is setting itself up to be, I will likely send out a brief update by tomorrow’s open. There were a good number of short-term indicators that flashed “imminent low” for this week I will discuss

If you would like to be notified by email when a new post is made here, please sign up HERE

Anatomy of The Stock Market Crashes of 1929 & 1987. Can It Happen Today?

Today is the 30th anniversary of the stock crash of 1987. All week long there has been a stream of recountings, anecdotes and comparisons to today’s market. While I love nostalgia as much as anyone, there are almost no valid comparisons to 1987 and it’s pretty much a waste of time to take that argument. Writers, analysts and investors who insist that stocks are about to crash like 1987 are either perma-bears who have been wrong for the past 8 years, people trying to make a PR splash or just plain ignorant.
Real crashes are generational events. They are market events, not economic ones. We saw one in 1929 and not again until 1987. 2008 was absolutely not a crash. It took weeks, months and quarters to unfold and it was very fundamental with the financial crisis. Flash crashes in 2010 and 2015 were definitely not stock market crashes. Remember, 1987 saw more than 22% cut from stocks in a single day and more than 30% from high to low.
True crashes don’t just come out of the blue and they do not occur from all-time highs. My basic study of crashes concludes that an asset literally melts up into a peak before the seeds of a crash can be sown. By melt up, I am talking about an historic rate of return over the past 6-12 months. Look below at what happened in 1986 and 1987. The Dow surged 50%+ in less than a year.
In 1928 and 1929 the rally was even more vertical as you can see below although it’s a little more difficult to make out.
Stock market crashes are also preceded by a repeating topping pattern where price melts up to the final high. After that, what’s viewed as a normal and healthy 10% correction sets in over the next month or so. Stocks find their footing and rally to a secondary peak which is lower than the all-time high. You can see this just above on the right side of the chart in 1929.
It is from this peak that the snowball begins to head downhill. Snowballs typically grow and grow as they accelerate more and more until they are at their largest the split second before they hit the bottom.
Today, we have absolutely nothing that resembles the price action of 1929 or 1987. It’s idiotic to even try and make that case. If stocks crashed like they did previously, we would be looking at a decline of thousands of points in a single day. Additionally, stock market participation was very narrow in the months leading up to the crashes in 1929 and 1987. The final advances were both led by very few stocks with the vast majority already experiencing double digit declines well before the decimation was even seen. That’s certainly not the case today as the NYSE Advance/Decline Line just hit yet another all-time high as you can see below.
Finally, although crashes are not fundamental economic events, there are certainly triggers and accelerators. In 1987, newly appointed and among the worst Fed chairs ever, Alan Greenspan decided to sharply raise interest rates to fight an inflation problem that didn’t exist. Additionally, Treasury Secretary, James Baker, engaged in a war of words with the Germans over their currency and even went so far as to threaten to devalue the U.S. dollar. Lastly, the strategy du jour, portfolio insurance, somehow seemed like this brilliant idea where portfolio managers would use computer programs to sell stocks the lower they went. And the lower they went, the more stocks were sold. And on and on and on. Talk about insanely ludicrous!
One day, the stock market will be set up again for another great crash. But first, investors who lived through the previous one will likely have to be no longer involved or represent a tiny minority. Those who ignore history are doomed to repeat it, or at least watch it rhyme.

If you would like to be notified by email when a new post is made here, please sign up HERE