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Global Stocks Are Working on Synchronous Bear Flag Formations

Global Stocks Are Working on Synchronous Bear Flag Formations

2016-02-03 15:01:00
James Stanley, Currency Strategist
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Talking Points:

- The New Year has brought an apparent flip in sentiment, as ‘buy the dip’ has turned into ‘sell the rip.’ This has produced bear-flag formations in many global equity indices.

- Sentiment flips in markets take time, as bulls get less and less bullish as declines increase. Eventually the bulls wane and bids evaporate as negative sentiment takes over. This will likely be a risk for as long as the Fed talks up higher rates throughout 2016.

- Separate the ‘doom and gloom’ forecasts from those looking for a bear market. Markets (and economies) recess, that is normal. It doesn’t mean that the world is coming to an end just because stock prices move down 20 or 30%. Price action can be really helpful as it can allow one to take an objective look at markets based on real, actionable prices (and no fluff).

- Potential for volatility for the remainder of this week is extremely elevated. Make sure your risk management has been addressed, and if you’re looking for ways to generate trade ideas based on crowd positioning and sentiment, check out our Real-Time SSI. It’s free.

The past few weeks have brought a sense of relief to global markets after the back-breaking declines that came with the turn of the New Year. It only took a couple of days, but by the middle of the first week of the year fear was already running high. And while it normally takes months or even years for a bull market to turn into a bear market earmarked by negative sentiment and pessimism from investors, market tonality was as if a light switch had been flipped off as we came into 2016.

But major market turns take time. Even the Financial Collapse took a few months for sentiment to flip before the big moves came in. On the chart below, we’re looking at the anatomy of the Financial Collapse. Notice how this isn’t a one-sided type of thing. It takes time for bullish sentiment to wane and bearish sentiment to take over. As the moves lower get larger and the moves up get smaller, bulls wane and wane until eventually there is nobody left that wants to buy at those elevated prices. This is when terminal velocity comes in (this is when stocks moved down by 43.6% on the below chart).

Global Stocks Are Working on Synchronous Bear Flag Formations

Created with Marketscope/Trading Station II; prepared by James Stanley

But the fears that accented the declines with the New Year weren’t really new, were they? These were the same problems that the world has known about for a while, in some cases as long as six years, and numerous rounds of QE around the world may have been able to stop the bleeding, but ‘real’ growth remained a fleeting prospect. We even ended last year by writing about the top three risks facing global markets for 2016, all of which have already begun to become an issue: In part 1, we looked at an Asian Slowdown. In Part 2, we looked at the Commodity Carnage, and in Part 3, we looked at the rate conundrum from the Federal Reserve.

So these issues have been known. And now that stock prices have begun to move lower, the media has started to focus on the impact of what may happen from the continued development of any of those three themes as global markets have all seen an increase in struggle.

But there has been no shortage of bears in financial markets over the past six years. In the industry, we even have a nickname for these folks: We call them ‘perma-bears.’ Because no matter how bright the sun might be shining, these folks find a way to figure out how that sunshine is going to lead to lower stock prices. There’s always some relationship. And for the past six years of QE and other ‘extraordinary measures’ being employed by Central Bankers, these folks have been very, very wrong as their predictions of doom and gloom have been run over by Central Bank liquidity being jammed into markets, bringing stock prices higher and higher, running through stops on all of those short positions.

But the big driver over the past six years has been Global Central Banks. As the Fed spent much of 2015 bantering about a 25 basis point rate hike, the rest of the world began to shudder with fear as the prospect of tighter monetary policy became a very realistic prospect. Chinese stocks began to collapse in the summer, with global markets feeling the pain in August and September; and this finally caused the Fed to back off of rate hikes.

This then brought stock prices higher, and eventually, the Fed felt that the economy was healthy enough to kick rates up. But even as they were about to raise rates, red flags were everywhere. Chinese stocks, despite their amazing come-back, were still working in a bear flag formation. The chart below was taken from the Market Talk article on December 14th, just ahead of the FOMC December Rate Hike.

A few days ahead of the FED, the Shanghai Composite was in an up-trending channel (Bear Flag)

Global Stocks Are Working on Synchronous Bear Flag Formations

Chart taken from Market Talk, December 14th 2015; prepared by James Stanley

In the chart below, we’re looking at the updated version of that setup. The up-trending channel was broken on the first day of the New Year and stock prices haven’t shown any signs of slowing down as of yet.

Updated Bear Flag on the Shanghai Composite

Global Stocks Are Working on Synchronous Bear Flag Formations

Created with Tradingview; prepared by James Stanley

What’s so different ‘this time?’

What’s different this time is the Fed and their continued persistence towards higher rates. To this day, the Fed is expecting to hike rates a full four times in 2016 while markets are expecting one, maybe two depending on the day. While we’ve had some hiccups in the past, we’ve had a pattern of the Federal Reserve coming back to the table with some type of plan to assuage investors’ fears. This isn’t happening this time, nor has the Fed shown any signs of backing down yet. On the chart below, we’re looking at that in the S&P 500. We’ve outlined each of the major rounds of stimulus by the Central Bank, and notice how each round just propelled stock prices higher and higher.

Global Stocks Are Working on Synchronous Bear Flag Formations

Created with Marketscope/Trading Station II; prepared by James Stanley

So, we may be at a turning point: A turning point in which stock prices are headed lower and the Fed is still ready to hike. Ms. Yellen alluded to as such in December, just ahead of that first rate hike in nine years when she said she felt a greater risk of a recession without a rate hike. This showed the pressure that six years of low rates has done to retirees and pension portfolios.

So, many are out there saying bad things about the Fed. And to be sure, there policy and communication at this point has been confusing. The prospect of continuing with forward guidance in a rising rate environment seems very much like trying to drive an 18-wheeler down a crowded highway in reverse. Even if you could see where you’d be down-the-road, you have a giant caboose in front of you creating considerable movement in the environment in front of you, and this only increases your chances of a gigantic mishap.

The problems in the American economy, through deduction of the simple fact that monetary policy has been on full-blast for the better part of six years, is a fiscal issue. The same can be said for Europe, and this is the same thing that they’re struggling with in Japan. The Fed may be nearing a point where they begin to put the onus of fiscal policy back where it belongs, on politicians.

But until the Fed backs down, we’re likely in for considerable volatility because this is the point where something ‘new’ gets priced-in.

And be really careful of chasing stock prices in the same way that you have over the past six years. Those dips can look really appealing when you see the S&P 500 moving up by 1 or 2% per day, but to put this in perspective, the S&P is working on the same formation that Chinese stocks were just seven weeks ago. A massive bear flag has formed (shown below):

Global Stocks Are Working on Synchronous Bear Flag Formations

Created with Marketscope/Trading Station II; prepared by James Stanley

This isn’t the only similar setup. There’s also a bear flag in the Nikkei, and after last week’s burst of strength on the bank’s move to a negative rate policy, stock prices have begun to move back down and the channel is currently in the process of breaking:

Global Stocks Are Working on Synchronous Bear Flag Formations

Created with Marketscope/Trading Station II; prepared by James Stanley

And to round out the major continents, we wanted to finish with the most bearish of these three markets in the DAX. That bear flag has already broken and was very short-lived.

Global Stocks Are Working on Synchronous Bear Flag Formations

Created with Marketscope/Trading Station II; prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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