As an avid football fan, there’s nothing more frustrating than a play where your favorite team’s defense comes up with an interception, only to then fumble the ball back to their opponent. I moved to San Diego in 2005, and the name Marlon McCree still makes Chargers fans cringe. It was January 15th, 2007 and the Chargers, who were the consensus best team in the AFC, played the Patriots in a divisional-round playoff game. The Chargers led 7-3, then 14-3, then 21-13 with roughly 6 minutes left to play. Tom Brady was facing 4th and 5 at the Chargers 41 when he was intercepted by Marlon McCree…only to then see Troy Brown strip McCree of the football, forcing a fumble that was ultimately recovered by the Patriots (click here to watch the play). Brady and company made the most of their second chance, finishing the drive with a touchdown and successful two-point conversion, tying the game at 21-21. They’d go on to win the game, and the Superbowl, and 11 years later Chargers fans are still wondering “what if”? (and Patriots fans are still gloating).
The S&P 500’s price action this week was analogous to one of these weird interception fumble plays. The bears intercepted the bulls right at the all-time high for the index. The S&P 500 traded as high as 2,939.86 on Wednesday, 1.05 points away from our all-time high at 2,940.91, and then declined -2.40% into Friday’s low at 2,869.29. It’s from here where it appears the bears then fumbled the ball back to the bulls, as the S&P 500 reversed course into Friday’s close, which provides a hint of optimism into the week ahead. As of Friday’s close, the charts are now sporting an upside pivot just above September’s low at 2,864.12 and September’s closing low at 2,871.68. The successful “throwback” is also intact, as Friday’s bounce off the ropes leaves alive the idea of strong support at and around prior resistance. (Not to mention, there also seems to be a mountain of evidence supportive of a short-term bounce at the very least, from the VIX, to bar chart patterns, to put/call ratios, to a variety of indicators)
The trillion dollar question now is, who’s going to come up with the ball at the bottom of the pile? This is where there’s far more uncertainty at the moment. From a causality perspective, the easy narrative is to assign blame for this week’s downside reversal to interest rates. Shortly after the yield on a 10-Year United States Treasury bond (TNX) broke out to a 2018 high, the S&P 500 found its jitters. Therefore it’s easy to lean on the idea that should TNX continue to ascend, then the bears will likely come away with the football and the price of the S&P 500 will descend below September’s low over the week ahead, regardless of the mountain of evidence in support of upside reversion. This is a bit worrisome in my opinion because TNX has absolutely nothing but air above, i.e., bond prices are in free fall and lack nearby support . There’s no known support to the price of a 10-year United States Treasury bond until its yield is in ~3.65% region. A sprint toward ~3.65% over the week(s) ahead will undoubtedly mark a mild form of interest rate shock that will likely affect the actions and behaviors of market participants, generally bringing about panic-like selling from weak hands. Remember, rising interest rates alone aren’t necessarily a damaging sign regarding the future price of the S&P 500. But rapidly rising interest rates in near parabolic fashion is a drastically different conversation, and this would likely mark a bad omen to the present and future price of the S&P 500. The bulls would much prefer the era of "TINA” dies a slow death, not execution-style.
We also have the quantitative aspects of Thursday and Friday’s price action to contend with, which historically runs counter to the hint of optimism the bulls are feeling, and suggests it’s indeed the bears who’ll come away with the football. Objects aren’t always what they seem in the world of markets, like bearish outside reversal days being far more bullish than bearish forward-looking over any measurable time frame, or “head and shoulders top reversals” generally being a better time to press buy than sell. So lets define Thursday and Friday’s price action for the S&P 500 as consecutive trading days with the following:
-1% or worse daily drawdown below the prior session’s close (i.e., trade down more than -1% at some point during the session)
-1% or better daily close relative to the prior session’s close (i.e., close down less than -1% for the session)
Daily close above the 200-day simple moving average (200MA)
We’ll call these “back-to-back u-turns”. Friday marked the 141st “back-to-back u-turn” since 1970. When comparing the forward return tendencies of the S&P 500 in these 140 prior samples to the 12,275 trading days since 1970 that simply closed above the 200MA, we can see a major dent in forward returns. For example, since 1970 the average forward 10- and 20-day return for the S&P 500 following a trading day that closes above the 200MA records at 0.41% and 0.80% respectively, with win-rates of 60.54% and 63.05%. However, the average forward 10- and 20-day return for the S&P 500 following “back-to-back u-turns” records at just 0.11% and 0.25% respectively, with win-rates declining to 51.43% and 55%.
We can then take this a step further and isolate all “back-to-back u-turns” that have occurred in the month of October, and that’s where things get really weird. In zooming in on October our sample size deteriorates down to 14 prior instances, so the integrity of the exercise destroys any semblance of statistical significance, but I found it fascinating that “back-to-back u-turns” in the month of October have almost exclusively marked negative returns 10 days out. 1987 is in the data set too, and that’s always a bit spooky. Taken literally, “back-to-back u-turns” leave the driver traveling in the same direction they were originally traveling, analogous to back-to-back turnovers in football - the same team has the ball. If the bears grabbed control of the ball on Wednesday, then recorded “back-to-back u-turns” on Thursday and Friday, it would seem the bears may actually have the ball at the bottom of the pile.
If the bears do have the ball at the bottom of the pile, then the trillion dollar-trillion dollar question becomes just how long will the bears keep the ball? Will the bears go three and out, analogous to only a minor new low being set over the week ahead, or will the bears retain possession and perhaps bring the S&P 500 down towards the ~2,800 mark over the week ahead? Furthermore, is there any possibility the primary uptrend is over, and the bears will have the ball for the next year-plus?
While anything’s possible, it’s important to realize that one week of pain doesn’t eradicate six months of gain. Coming into October, the most volatile month of the calendar year, the S&P 500 had increased six consecutive months and managed to set a new all-time high in the vaunted month of September. Six-month winning streaks have always, yes always, seen a rather meaningful drawup from month end signal date close at some point over the forward 1 year. Furthermore, following six-month winning streaks, the S&P 500 tends to trade down from month end signal date close on average by -4.96%. With month end signal date’s close being September’s close at 2,913.98, it’s perfectly normal for the S&P 500 to trade down towards ~2,770 at some point over the forward 1 year. Perhaps the bears are getting the drawdown out of the way, sooner rather than later, just in time for us to flip the calendar to the favorable portion of the calendar year. Then comes the drawup.
So for now, there’s maximum uncertainty in the short-term as the bulls and bears wrestle for possession. We can only guess how many times the ball will change hands at the bottom of the pile. However, as we head into the heart of the 4th quarter, it’s patience over panic, and it’s highly likely the Bulls will regain possession and embark on a scoring drive. Long-term investors must exercise discipline in adhering to their long-term investing plan. Remember, weak hands don’t get paid. Odds are, strong hands will be handsomely rewarded for tolerating the small and moderate losses that could occur over the weeks ahead, and are necessary for you to put up with in order to invest for success over the long term.