We are spoiled rotten of late. It seems that no matter the dip, the market takes off out of a “V” bottom and never looks back. But now, as the nominal 18-month cycle matures, the market is settling back into more typical behavior. Let me digress.
I talk about cycles incessantly. The reason is, cycles give us context. Just like you can take a quote from someone out of context and render the opposite meaning, so too you can take a peak or trough in the market out of context and get the wrong impression. The quote example leads to inconvenience. But the market example can cost you money.
Last March, the markets bottomed a number of cycles simultaneously, from the nominal 54- month (four-year Presidential cycle) on down to the nominal 18-month, 40-week, 20-week, etc. That is why the dip was so pronounced. When long-term cycles nest with all the shorter-term cycles below them, we experience the most pronounced corrections. The Mental China Pandemic was simply the catalyst – but the dip would have occurred regardless. Fundamentals can exaggerate the amplitude of the cycles, but the nest of lows would have presented anyway. Here is an example of how the 9-month cycle is phased:
While it is true that the nest of cycle lows exacerbates the dip, it is also true that the rally on the other side of it is usually something to behold. The new bull run that comes out on the other side is usually so strong that the shorter cycles are barely discernable at all, especially in the first nominal 54-month cycle that ensues. In other words, the market barely dips, and when it does price only spends a nanosecond at the trough. We have seen this over and over since last March.
The aforementioned behavior is different in more mature cycles. In a typical dip as the market matures, there is a retest after the first run out. That is how financial markets were behaving before last March. You might have heard this described as “Elliott Waves” or “three pushes.” Essentially, these theories reference the fact that the markets tend to move in five waves; three advancing waves and two correcting waves as can be seen in the chart below:
Closely examined over the years, these waves have particular characteristics. There is no need to review that here – as it is a science in and of itself. Notably, for this morning, the first 1-2 sequence involves anywhere from a 50% to 80% retracement of the first run out or blue “1” wave as labeled above. This forms the “2.” And this makes sense because at this point in the “1” wave rally, there are a series of declining peaks and troughs leading into the dip, so until the market has a dip that presents the first higher trough, few people jump on board. When the trough turns at a higher level than the troughs preceding it, you have a classic trend reversal and everyone jumps aboard. And not just buyers come flooding in, but the shorts also panic buy to cover. Hence the longer run in the “2-3” sequence as compared to the “1” wave illustrated above. Makes sense, right?
Then there is the head and shoulders pattern. Recall our discussion back on February 24th. Here is a refresher illustration, using a reverse head and shoulders, the relevant pattern this morning:
Recall that I pointed to this pattern as a typical pattern presented when bottoming a cycle. As you can see, it also marks the transition of a trend reversal, which is what we see at cycle lows.
So where am I headed with all of this? Take a look at the NASDAQ 100 index as it currently presents this morning? How does this all tie together?