Fear takes many shapes during extremes. There is fear of losing money in a dramatic downturn (market fear) and fear of missing out (FOMO) when markets bounce back. It is human nature to feel the urgency of both types of fear. The most successful investors deal with these fears by being focused on data as well as understanding the possible outcomes and the probabilities that those outcomes may present.
The big question today that is being asked over and over relates to investments from this point forward: where do we go from here? President Trump announced a temporary deal to open the US Government last Friday after a historical 35-day partial-shutdown. The United States and China are in the middle of a 90 day “truce” in the trade war that expires at the beginning of March. The UK has been embroiled in negotiations to exit the EU and to date have no agreement in place and “Brexit” remains a big unknown.
With so many large geo-political risks, it is very difficult to look at fundamental data alone. There are some powerful market technical trends and models that can be helpful in examining where we can go from here. None of these models is perfect, but it provides a framework for helping us to control both market fear and FOMO. It does not provide guarantees, but it does provide context.
I look at “typical” patterns that are observed in many market corrective markets. Trend lines develop over time and therefore as a market correction takes place, it becomes easier to identify them and look at the possibilities.
There are typically a few phases that follow extreme market corrections; corrections that approach roughly 20% losses from a high point but are not accompanied by a recession. Once a bottom has been established, which often takes a few weeks to be recognizable, there is a 1st phase of the recovery that takes place. The distance below the trend line that the low was huge! That is why the 1st phase recovery has seemed so strong.
We may be approaching the end of phase 1, which is often met by those investors who are not fully invested, with increasing FOMO. However, until the downward trend line is breached to the upside, and we see successive closes above the trendline, we will not have an overall change of direction. The 2nd phase is often a retest of the lows but with less fear than the initial drop. The 3rd phase is where we would be looking for a breakout and we can become more optimistic that the overall downtrend is over.
None of this is a guarantee that we will experience exactly what this picture shows. If it was that easy, we would simply trade in and out of the market at troughs and peaks, but it does help us to see where we are in the overall trend. It is also important to understand that we have not yet broken, even after 5 straight weeks of gains, out of the overall downward trend. The good news is that it might be getting close! Knowing what could happen, can certainly help control the fears that can often take over in fast moving markets.
Certainly, there are many unknowns in our world today. Those risks are driving markets. Unfortunately, most of the risks are derived from geo-political risks. They are notoriously difficult to navigate compared to corporate risk, interest rate risk and even economic risk. Largely because we have very little control of the situation and we must sit back and wait for resolutions, and patience is extremely difficult to cultivate.
Hopefully having some data and a framework to understand from a macro point of view helps both those who are fully invested now as well as those who are taking a more cautious approach. In the absence of a recession, we would expect to recover from this large correction in a matter of months. As data continues to evolve, we will have a better view of possible outcomes.
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