SP500 to Drop 14%
I am projecting the SP500 to drop 14% from the closing highs six weeks ago before finding a tradeable bottom. The week that QE3 was announced saw the SP500 close at 1465.77. By my calculations, the SP500 will bottom near the 1260 level, which is nearly 150 SP500 points from today’s prices.
So how did I arrive at these numbers?
Figure 1 is a weekly chart of the SP500, and the indicator in the middle panel is the cyclical adjusted price earnings ratio (5 year). The indicator is wrapped in trading bands that looks for statistically significant extremes over the prior 52 weeks. The indicator in the lower panel is an analogue representation of our “dumb money” indicator that I show every Sunday in the weekly sentiment wrap up. With the indicator in the “up” position, investors are too bearish in their market outlook, and these typically are bull signals. What we know about investor sentiment is that it is cyclical. In other words, bearish sentiment will follow bullish sentiment and so on. Bullish sentiment peaked 6 weeks ago when QE3 was announced, and it has been rolling over with price ever since. If the present is like the past and if the cyclical nature of sentiment persists (and I have no reason to believe that it won’t), then investors should turn bearish at some point in the future.
Figure 1. SP500/ weekly
But the question remains: at what point?
Now direct yourself to CAPE (5 year) indicator in the middle panel. In the overwhelmingly majority of the time in the past 22 years, the CAPE (5 year) will tag the lower trading band when investor sentiment turns bearish (i.e., bull signal). So going forward, my expectation is that investors will need to turn bearish on the markets (remember sentiment is cyclical) and this should coincide with the CAPE (5 year) tagging the lower trading band before prices bottom. What would it take to get prices to tag the lower trading band? The SP500 would need to drop about 150 points from its current level. This would put the SP500 at 1260.
Lastly, any downward price move that doesn’t result in investor sentiment turning bearish will be pretty much the same. The ensuing bounce will be like the last 5 months, and it will be sub-optimal.
Category: Equities
There is also the weekly trendline around that level (1260). I also expect a bounce/reaction there on the weekly chart.
Turtle:
That is correct
It is also possible that we see marginal higher highs over the next 1-2 months similar to early 2011, and perhaps form a similar H&S pattern top.
The beauty of TA is that one can see almost anything one wants to. For instance, it’s also possible that we’ve seen the left shoulder on the weekly chart in early 2012 and now we’re on the way down from the head.
Spuds:
It is possible but any bounce that occurs BEFORE sentiment turns bearish is likely to fail and be more of the same.
I have been stating this for a long time; any market that doesn’t clear itself of the weak hands is a market top; on many time frames we have yet to see any real fear
Yeah I read ya, I’m just saying the left shoulder drop of that 2011 H&S top didn’t cause a sentiment extreme and made a new high shortly afterward (head) as CAPE just bounced off the top trend channel. The head drop followed and caused a bearish sentiment extreme, but did not reach new highs or create a lasting rally (instead creating right shoulder). I just think something similar “could” play out here.
I agree that sentiment extreme plus the CAPE indicator looks like a good criteria for a major longer-lived bottom formation.
Just trying to look at market from as many points of light as possible
Thanks Guy. This rally has featured a very lengthy period of bullish sentiment based on your data. Is that positive for the market moving forward, or, a contra-indicator based on your data set?
I am not sure what TA has to do with this — we are analyzing sentiment and CAPE
My TA or analysis of price has nothing to do with patterns….I systematically identify support and resistance (i.e., the pivot points)
Hi Phil
I feel that these constantly rising markets that keep going higher without periods of bearish sentiment are failure prone; I have looked at this with the Rydex data on a daily basis as well as the weekly sentiment data
It is good for the market to clear itself out
No disagreement there. 1260 sounds like a reasonable entry level assuming we get some bearishness. Things look too overbought to me, not just from a sentiment perspective, but from a results perspective – which just don’t look too hot. Maybe we’re not in recession, but earnings growth has stalled, and revenues are actually taking it on the chin a bit. Not sure how bearish it is long-term (all this stuff is cyclical), but the market needs to dig in and burn off the sentiment before I’ll take a risk on it.
It’s a good timely call with a price level Guy, because earnings are going nowhere.
I can wait as long as need be.
The break below 1390~ on the SPX will show some bearish pressure to the downside. That is where the longer term uptrend channel is from 2011. That could easily bring some selling pressure into the market. Watch 1390~ in the cash for support probably mid 1380′s for ES. Failure brings in downside action