Our analysis of price action indicates that conditions for a significant move in the stock market have developed. We provide more information about the signal and the market direction in this premium article. To access the full report, you must subscribe to Premium Articles or All-in-One.
We have discussed the Momersion pattern in previous premium articles. We now believe that the formation of this pattern is complete.
As shown in the above SPY ETF daily chart, this Momersion pattern has formed three times in the past before a significant correction. However, here is what we think and our logic regarding this pattern:
- The historical sample size is small, but this is always the case with patterns signaling a large correction due to the low number of these corrections.
- Technically, we believe this Momersion pattern indicates that the conditions for a large correction are now in place.
- Fundamentals can always invalidate technical patterns.
(1) Anyone looking for statistically significant patterns that precede large corrections and bear markets will not find any simply because there have not been many such events in the recent history of the stock market.
(2) The pattern indicates a surge in momentum followed by a rapid decline, a small rebound, and then another drop. The last previous formations before the sot-com, GFC, and pandemic bear markets are quite similar, if not identical. Note that price action patterns are neither essential nor sufficient in predicting the future trajectory of the market.
(3) Fundamentals can always invalidate indicators that are derivatives of price. We believe the central banks and the new administration will do anything they can to prevent large stock market corrections. However, some of the decisions may involve backing off promises, and that could force cognitive dissonance at the highest level and conflicting signals. If uncertainty rises, the market may fall despite any interventions from the central bank and government officials.
Based on our analysis, we believe this is the time to consider tail risk hedging for equity portfolios. Tail risk hedging is expensive, but we think this year some market participants will pay the premium.
Tail risk hedging is all about market timing. Otherwise, the costs accumulate and severely impact performance. The simplest tail-risk hedge is holding only cash. With short-term rates elevated and a lower probability of significant rate cuts this year, some market participants may decide to sell and buy T-Bills. However, much will depend on the outflows from the large passive index funds. Predictions are impossible, and this necessitates precaution when uncertainty reaches crucial boundaries. We think this is the case right now, but investors and traders should do their own homework while taking into account their risk aversion parameters.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
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