Correction could be soon ...

Discussion in 'General Discussion' started by Brooks, Jan 24, 2018.

  1. Brooks

    Brooks Well-Known Member

    If you look at the attached graph of the S&P 500, the market is way, way overbought.
    The time seems ripe for a substantial correction. Things can't keep going up indefinitely.
    This is causing me to consider more bonds in my long term portfolio.
    Curious if others share this opinion ...
    Brooks
     

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  2. kgbist

    kgbist Member

    Bonds are overvalued as well it would depend what exactly you are buying.. If they continue raising rates than the bonds especially the longer duration will be hit as well.
    I personally like the gold hedge but it is up considerably in a short time.
     
    Ice101781 likes this.
  3. PK

    PK Well-Known Member

  4. status1

    status1 Well-Known Member

    Maybe not indefinitely but it can still go up (Irrational exuberance)
    What do you call a substantial correction ?
    Yes if you look at that chart it looks like a lot but if you look at a regression channel it's at the top of the channel and it's pushing it wider so it can certainly correct at any time it's just a matter of when and how much
    I think a correction to 2700 to the beginning of the year seems reasonable so that's only about 5%and that's just bringing it to the middle of the channel after that it can start going up again or go sideways
    The question is what's going to be the trigger ?
    Is it the news about apple , the next shut down , the interest rate ?
    Even so I believe the correction will be small and quick because of the recent buy the dip mentality
    As long as Trump is in the office and there is no major catastrophe the market will keep climbing
    Some experts predicted 3000 for the SPX at the end of the year but at this pace it will get there in just a couple more months so a small pullback or maybe sideways move could be in order
     
    Mark17 likes this.
  5. Gabor Maly

    Gabor Maly Well-Known Member

    While long term bonds will be hit from one side (raising interest rates) they may still continue to provide a "hedge" in case stock market crashes assuming historical correlations hold. Ray Dalio with his "all weather portfolio" making 6% annual in past 20 years with very small drawdowns in 2008 is mid term and long term bonds heavy however he has recently made some comments that Bridgewater has slightly tweaked this strategy given the possible end of the bond bull market.....likely they have decreased the weight of long term bonds and added more weight to the other asset classes (gold, commodities,etc), possibly adding short term bonds to the list as Peter has mentioned above.
     
  6. SVL

    SVL Well-Known Member

  7. Kevin Lee

    Kevin Lee Well-Known Member

    Here's my belief :

    1. Market doesn't need to come down just because it has gone up a lot. Neither does that mean it has been overbought.

    2. Market isn't necessarily too expensive just because it has gone up a lot either. Whether market is cheap or expensive has to be viewed from P/E perspective. But even P/E alone isn't a good metric. What we really need to do is to compare the market earning yield with long term bond yield. That means reverse P/E to become E/P and then compare with long term bond yield.

    3. When earning yield is low relative to bond yield, then there is a risk (but not necessarily a guarantee) that the market will correct. I did a quick research and here's what I found.

    4. I got the necessary data from this webiste http://www.multpl.com/10-year-treasury-rate/table/by-month. And then I looked up all the bear markets since 1968, that's 50 years of study, from this website http://traderhq.com/illustrated-history-every-s-p-500-bear-market/ I calculated the SPX earning yield and then took the difference between the earning yield and the 10 year bond yield.

    What I found is that before every single market crash, the yield spread was always negative.

    upload_2018-1-25_11-36-56.png

    Take a look at the spreadsheet. All the bear market months are color coded. Take a look at the yield spread. Check out the yield spread immediately before the color coded rows. However, take note that a negative yield spread doesn't guarantee a crash, but negative yield always comes before every crash. In other words, no bear market has ever happened when the yield spread was positive.

    So what's today's yield spread ?

    upload_2018-1-25_11-40-39.png

    This is what the research and the data says. This a well-researched topic and there are many research papers online if you're interested. You can form your own opinion. To me this theory does make logical sense because as the earning yield of companies is too low relative to bond yield, it's better just to put money into bond.

    Therefore, I don't think the market is going up primarily because of the crazy central bankers pumping in too much liquidity or the greedy corporate executives playing financial games with their earnings, although these do have some influence. Rather, it's because earnings have been growing steadily and in an environment where inflation is tame. That's a perfect combination. As a result, despite the huge rally, the yield spread is still not in a danger zone.

    I would watch the inflation chart closely. If inflation starts to go up aggressively, fed might take more aggressive action. That will cause the yield spread to narrow and eventually turn negative. That's when I'll start to be worried.

    upload_2018-1-25_11-47-40.png
     

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    Last edited: Jan 25, 2018
    Lifeson, Frank, Shin and 9 others like this.
  8. Marcas

    Marcas Well-Known Member

    I suppose it would be good to define what 'correction' we are talking about. I suspect Brooks in OP might have more general view than '10% down move in up market'. While Kevin's argument has it's weight and brings some insight, from more practical point in periods like we have - extended run up - trader should expect some form of reaction despite yield spreads and get ready by dusting off 'Plan B' or maybe putting little more $ to small hedges but without giving too much in case of continuation. In Kevin's scenario Black Swan Hedges are much more important (if one wishes to stay in the market). So I wouldn't take Kevin's post as 'nagh, no correction on horizon'.
     
  9. PK

    PK Well-Known Member

    A (very) minor hint to a correction coming soon (2-6 months) maybe the emerging divergence between the Dows Industrial and Dows Transportation Average index. Look how the DT is reacting (see attached picture) and compare it yourself to the DI or SP500. Old fashioned way of looking at the market? Of course. In the past it worked. This time it will be different? Let's see.

    upload_2018-1-25_21-51-33.png
     

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  10. status1

    status1 Well-Known Member

    Another hint is the VIX which is off the lows and staying up as the market is going higher which usually is a reverse relationship
    I see AAPL is down for the past 2 days so that put the brakes on SPX
    I have a feeling a correction might start as soon as next week in Feb
     
  11. DGH

    DGH Administrator

    Twenty five years ago floor traders had relatively precise (and usually accurate) metrics for anticipating a correction. I kept a copy of these metrics on my desk, and used them often. They are not as valuable now, just as P/E or P/B estimates have been superseded (for the most part) by cash flow, EBITDA, net sales, etc. It's easy to simply shrug and say, "Who knows?" While that simple message carries an element of truth, I fully agree with the above statements regarding hedging. I still remember 1987 as the ultimate shocker. And, we should avoid the Alfred E. Newman "What, me worry?" approach and its corollary "bring it on".
     
  12. Neil

    Neil Active Member

    Dan, Just out of curiosity (since I wasn't trading 25 years ago) what metrics did floor traders use pre home computers (which allow the little guy better market access), and computerized and high-frequency trading? It appears that some (many???) market movements in the current environment are completely unexplainable. Like someone somewhere flips a switch and a trading algorithm that can't be discerned by mere mortals kicks into overdrive, whereupon the herd mentality takes over and we're all just along for the ride. Then the talking heads start spouting their wisdom trying to explain market movements that really don't follow a logical progression.
     
  13. Kevin Lee

    Kevin Lee Well-Known Member

    Marcas,

    Market's short term gyrations are unknowable. Market can do whatever it wants in the short term. The yield spread theory applies to bear markets, which is at least 15% to 20% correction and usually span over at least a few months or longer, depending on who's definition you use. Temporary market drops of a few percentages here and there happen all the time and they are not in the yield spread analysis.

    Therefore, my post is related to the view of whether current market is crazily priced since it has gone up so much so quickly. If you believe in the yield spread theory, which I do, the answer is no. However, it doesn't mean in the short term a sudden crash cannot happen. You cannot predict what North Korea or other terrorists might do. Therefore, it doesn't mean that we don't have to worry about the downside risks for our income options. We always should because options trades are not long term investments.

    What the analysis did for me personally is I continue staying long for my long-term investment portfolio. Some people have been taking money out, but I'm not. Not yet. Not until I see inflation creeps up and the yield spread narrows. If the market drops in the meantime, I'll add to my portfolio instead.
     
  14. Marcas

    Marcas Well-Known Member

    Kevin, no argument. Type of trading one is doing is quite important in thinking about how to go about possible market correction/reversal.
    I'd like to ask you about SPX yields - how do you get them, what method do you use?
     
  15. DGH

    DGH Administrator

    Hi Neil. I typed those metrics and pasted them into a daily log book. Unfortunately, I lost the book in a move. However, I remember that several of the parameters were based on market internals, e.g. NYSE highs-lows, advance-decline ratios, etc. Those are easily obtainable now, of course. Other metrics used then were known only to the floor traders, but could be obtained from Barron's and a few other publications. As you pointed out, no one knows exactly when a major correction will hit...just as a few small temblors do not predict the "Big One", as we say in California.
     
    Mark17 likes this.
  16. Kevin Lee

    Kevin Lee Well-Known Member

    I got the historical P/E from this website http://www.multpl.com/ and then flip P/E to become E/P.
     
  17. status1

    status1 Well-Known Member

    Maybe that worked in the past but I am not sure that is a good tool anymore
    I did this price comparison between DTX and SPX and while the DTX had a few dips the SPX just kept going higher
    Of course it's hard to compare to anything when everything is going higher

    STX to SPX compare.PNG STX to SPX compare.PNG STX to SPX compare.PNG
     
  18. Brooks

    Brooks Well-Known Member

    Wish I would have been wrong on this ...
    Not a fun time for bullish credit spreads and similar.
    Brooks
     
    Jerryb351 likes this.
  19. PK

    PK Well-Known Member

    Impressive spike in volatility; the first I saw since I have started trading Dan Harvey's RTT configuration with ES future options a year ago. I am really impressed how robust the RTT turned out to be during this black swan-like event, doing some standard adjustments and having a reasonable hedge in place. Unless the market drops another 10%, there is still a good chance to close the forthcoming expirations with a reasonable profit. My thanks and admiration to Dan for having created and shared this fantastic setup! :)
    chart.jpeg
     
  20. DGH

    DGH Administrator

    Thanks for the kind words, Peter. Good to hear that you weathered the storm.
     

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