One thing to notice in particular is that beginning towards the end of 2013 the market broke above the upper standard deviation band rather substantially. This is the only time this has happened during the recent bull market and is a sign of the more “irrational exuberance” that took place.
With the exception of the 2013 liquidity driven rally (courtesy of the Federal Reserve’s $85 billion per month), the market has generally corrected back to the 50-week moving average during the course of the current cyclical bull market. The current excess deviation above the long term moving average suggests that the current correction may indeed have more to go to be complete.
That thought is further supported by the lower weekly RSI which has only completed roughly 50% of a normal market reversion process.
Failure To Breakout
While the current sharp reflex rally from oversold conditions in the market was expected, it will be important for the market to breakout above the “double top” shown in the first chart above. A failure to do so will likely mean that a further correction process is in the works. The final chart below shows the current percent deviation of the market above the 50 week moving average. Normally corrections either revert to, or beyond, the long term moving average. Currently the market remains 5.61% above the long term mean but has been reduced from recent extremes.
With the Federal Reserve now extracting liquidity from the financial markets, it is conceivable that the recent correction was the beginning of a longer term consolidation/correction process from recent extremes. As discussed recently in “2014 A Bull Year?:”
“Could we have another bullish year in 2014? It is certainly possible as long as the Federal Reserve remains engaged in their ongoing balance sheet expansions.
But maybe the ongoing inflation of assets, without the underlying improvement in organic, sustainable, economic growth, will eventually lead to the next market bubble and bust. Of course, for anyone that has paid attention, such an outcome would be of little surprise.
The important point is that, as an investor, you need to pay attention to the ever decreasing reward/risk ratio of chasing the financial markets. The ‘low hanging fruit’ has long been harvested and the risk currently far outweighs the potential reward of being aggressively invested.”
There is one thing that is crucially important to remember – “we are all guessing.” While there are plenty of individuals currently prognosticating that the current bull market is still intact, and could indeed be proven right, they are only making an educated guess. However, it is also important to remember that most of these individuals on television have an inherent bias to sell you some product or service which keeps your money invested at all times for a fee. As I discussed recently in “The Truth About Wall Street Analysts:”
“While individuals believed that Wall Street was out to take care of them the real truth was markedly different. Wall Street got rich while they got poorer.”
I can only guess at the moment whether this short term correction is over. However, what I am quite sure of is that a much larger reversion in the market awaits us in the future. What will trigger that reversion will likely be something that is not even on the radar as of yet. Or, maybe it will just be the lack of the liquidity push by the Federal Reserve. Whatever the reason, it will be important that you manage the inherent risk in your portfolio because there will be no one from Wall Street telling you it is time to leave the casino.
(c) STA Wealth Management stawealth.com
This article is brought to you courtesy of STA Wealth Management which appeared at Advisor Perspectives.