Forget The Hindenburg Omen - Here's Another Possibility To Consider

• Five days of Armageddon
• Does the British market still lead the US market

Five Days of Armageddon

For some time, I have been drawing your attention to the fact that many intermediate indicators have been flashing buy signals that even in primary bear markets have triggered some kind of a rally. I still subscribe to the rally scenario. However, this week I saw an intriguing article by John Hussman of Hussman Funds. This article, which you can read here, observes that the current technical position is very similar to those that have preceded a market crash in the past. As you can imagine, it really got my attention, so I am going to discuss it in  this article.

Mr. Hussman observes that prior to a crash developing several characteristics appear to be present, and here I quote, “a retreat of about 14% over 10-12 weeks, a rebound between 1/3 and 2/3 of that decline, a fresh retreat that slightly breaks that initial level of support, a one-day barn-burner advance, and then a collapse as the prior support level is broken”. He uses examples in 1929 and 1987 and called this pattern the lead-up to “five days of Armageddon”. I thought this was a really interesting concept but was curious to see what happened prior to other equity price collapses. All together I observed five examples in the last 100-years. They developed in 1929, 1962, 1987, 2001 and 2008.

My pre-crash characteristics differed from his in marginal ways, but in principle, they are not dissimilar. I too observed the 14% decline, though the ranges used in my examples from the beginning of the pre-crash period ranged from 21% in 2008 to 10% in 1987.  Duration also varied from an approximate 7-weeks in 1987 to 40-weeks in 2008, though most were in the 10-15 week range. When looking at his charts, it seemed as though a five-wave decline preceded that one-day barn burner rally, which in turn, preceded the crash point. As a result, I adopted this five wave approach and also diverged from his observations by substituting a one-to-three day barn burner for his one-day advance. The result is basically the same in that the pre-crash rally, whether one or three days is a fool's rally that sucks in the unwary.

The examples of previous crash periods are shown in Charts 1-5. Chart 1 shows 1929, where the end-of-day data is used because since OHLC is not available in StockCharts for these early periods. The blue horizontal arrow flags an approximate pre-crash period and I do mean approximate. The red dashed line indicates the percentage decline from the beginning of the pre-crash period. In most cases this represents the actual bull market high. The five waves have been flagged by the red lines and the percentage figures at the top of selected waves represent retracement moves from the previous high. I have chosen just to highlight approximate 50% and 61.8% retracements, both of which fall into Hussman’s 1/3-2/3 retracement rule. In the case of end-of-day data, the pre-crash rally does not show up well, but on the chart Mr. Hussman uses, the sharp one day 1929 advance is apparent.

In this respect, the two-day 1962 advance in Chart 2 is quite striking, as is that for the 'pre 9/11' and fall 2008  crashes.

Chart 1

Chart 2

Chart 3

Chart 4

Chart 5

All of which brings us to the current situation, where Chart 6 features a five wave decline between December and the present time. This drop shaved off about 13% of the S&P market valuation. Note that the two post-December advances retraced a perfectly normal 61.8% and 50% of their previous declines.  Over the last four days, the normal strong 1-3-day rally has morphed into 4-days and has nearly retraced all of the price declines in February. If the “five days of Armageddon” pattern is to repeat yet again, that four-day advance would turn out to be the strongest pre-crash rally of any of our examples.

Chart 6

I concluded at the beginning that the most likely outcome is for the market to rally. We also have to remember that crashes are very rare affairs, which means that the odds of being able to predict one are pretty low. However, since the current pattern is not dissimilar to previous pre-crash periods it cannot be ignored. In this respect, a break to new lows would be the signal I would be looking for as confirmation. In the meantime enjoy what is likely to be a volatile and deceptive bear market rally.

Does the British market still lead the US market?

When I entered this business, which is more years ago than I care to remember, there was a rule of thumb that we followed. That rule stated that at market tops, look out for downside leadership from the British market because it had a good record of leading its US counterpart. The rationale was not that UK stocks had any special crystal ball characteristics. It was more that London was the home to far more international stocks and therefore, better reflected the world. In a rough sense, you could argue that London represented a sort of advance/decline line for global equities. As we all know, A/D Lines have a strong tendency to start making lower lows at market peaks. Over the years, this relationship has fallen out of fashion. Bearing this in mind, I thought it might be interesting to see whether this relationship still held. After all, the world is a much smaller place with corporations being much more multi-national and inter listings far more prevalent. Chart 7 shows that indeed the UK market did lead the US lower in 2000, but has not done so since. The shaded areas also point out when both markets move below their respective 12-month MA’s, as is currently the case, and it’s usually best to avoid equities on both sides of the pond.

Chart 7

To some extent we are comparing pound oranges with dollar lemons. In this respect, Chart 8 gets around the problem of distortions due to currency fluctuations.  That’s because it compares the S&P to the MSCI UK ETF, the EWU. Here we can see that UK equities led their US counterparts at both the 2000 and 2015 peaks by several months. The 2007 top though still experiences a simultaneous peaking.

It would be nice to see some leading characteristics at bottoms but this is just not the case, as the UK usually coincides or lags the US. One thing to bear in mind, is as long as both series are below their respective 12-month MA’s, as is currently the case, caution is the order of the day.

Chart 8

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.