Ruh Roh, looks like SPY's in trouble..Hey guys,
Thought I would do a written post this time because there is a lot of information to share!
So, if you follow me, you know I am mostly about math, but I also like to include the chart, some technicals and some fundamentals. And I think at this point in time its very critical to consider all these factors when analyze the price action we see.
So SPY is selling. To be honest, I am not surprised of the selling, but I am surprised of the timing. I thought it would wait till January, just chopping around and topping before doing the whole waterfall thing. But it decided to jump on the opportunity with FOMC's news release. We will get into that in one second.
So with that catalyst, SPY began its decline, over 2% in one day, closing below a loss of 2% on the day. We then opened slightly gapped up but failed to start, where we continued to tank.
So what is going on?
Fundamentals
The market got what it wanted, a 25 basis point cut. However, the guidance offered by the feds was a bit more realistic and sobering. The guidance essentially indicated that rate cuts would not continue for long and they don't anticipate anymore than 2 rate cuts into next year, leading to a period of rate purgatory so to speak. This is generally not great because it destroys the premise of "easy money". Easy money is money that people can get due to low interest rates and a surplus of fund availability. However, with the lack of rate cuts, we will hover at a stable albeit elevated interest rate with no outlook of when rates will be lowered and when interest rates will be cheaper.
This is bad, because in order for people to feel wealthier, they need to feel like things are cheaper or that they have more money, which isn't a direct consequence of prolonged rate hiking. This means that people will be less inclined to invest into unnecessary things (stock market perhaps) and keep funds safe for whatever the future may hold.
The reason the feds can take this stance is because the labour market is rebounding. This means that people are generally gainfully employed and can withstand the rate hikes / rate stagnation.
Not necessarily detrimental for the market, but in general, higher unemployment is good for the big picture of markets because it means rates will need to be lower.
This leads to the next fundamental topic, Money!
2024 marked historic deficit highs for the US, with 1.8 trillion deficit in 2024. And if you watched my video about SPX and the money supply, having a US index valued well over all the monetary supply in circulation within the US, its not a normal or healthy or sustainable thing, especially when the US is already experiencing grave deficits.
PE ratios
I won't get into this too much, but take a look at some companies PE ratios in relation to their fundamentals, things were getting a little off kilter here...
Now for the Math
If you followed me through the last little crash SPY / SPX did in the end of July, you would have remembered this video:
In this video, I explain my own theory of "corrections". From my own research looking at DJI and SPX (since both have histories since the 1800s), one thing I have noted is there are generally 3 stages of correction, from a math perspective.
Stage 1: Cubic Correation
This is a shallow correction and involves a correction to the 'cubic' mean of a ticker or index. It generally results when the ticker, specifically spy, exceeds the cubic mean by up to 5%.
Currently, SPY's cubic mean is 557, with the actual range being 555 - 559. Remember, this moves with each passing day. That is just as of right now, today's close. In 20 days the range will be up to 563.
These corrections are shallow and usually involve about a 5% to 10% pullback. As of right now, the cubic mean is approximately 8% away from the recent highs.
Stage 2: Quartic Correction
If the market isn't satisfied with a cubic correction (for general interest, in July we simply did a cubic correction back to 510 and then resumed the uptrend), we will see next a quartic correction.
This is a reversion to the quartic mean, which generally is an addition 10 to 15% away.
In SPY's case currently, the quartic mean is 544, with a range of 542 - 546/
This is a deeper correction but not necessarily a bear market. Quartic corrections usually are the halmark of "flash crashes".
Stage 3: Quadratic Correction, AKA Bear Market Cycle
In 2022 we had a quadratic correction, that was a regression to the quadratic mean. If you have been around for a long time and followed me through 2022, you will remember I called a move to 350s. Most thought I was nuts, but it was because SPY had already fallen through the cubic mean and that signaled that it was intent on following through to a quartic and possibly quadratic. It was confirmed relatively quickly in 2022, at least for me, that it was looking for a quadratic correction (i.e. bear market cycle) as it quickly fell through both cubic and quartic means.
Currently, SPY's quadratic mean is 475, with a range of 472 to 477.
Quadratic corrections take, on average, 6 months to a year, which is the normal bear market cycle.
Only once have I observed a fall below the quadratic range and that was in 2008 (obviously I wasn't trading at this time, but when I was testing these theories this was the only year where the market didn't get stopped by the bottom of the quadratic range, every other bear market/correction got halted at the bottom of the quadratic range or at the quadratic mean itself).
So what does this mean for you the trader?
It means relax. We haven't even seen a cubic correction as of yet. For SPY to assert a bear market cycle thesis, we will need to see SPY shoot through the cubic mean.
However, obviously vigilance needs to be maintained. This isn't the time to mindlessly buy dips until we see it finding support on one of the critical means.
Will it correct to the means? Yes, mostly likely we will see at minimum, a cubic correction. The reason I think this is just the fundamentals currently support it.
Will we go lower than the cubic mean?
Hard to say. No one can be sure, obviously. The economic situation isn't super precarious, so I am skeptical of seeing an overly profound dip or the commencement of a bear market, but I will be diligently watching where support is found.
How do we know if it doesn't want to correct to one of the means?
This is a good question! Most pullbacks involve at least a correction to one of the means, but there have been times where it bypassed, only to circle back in about a 6-month period.
We will only be sure that SPY does not intend to mean revert if we break a new high from the current high (aka a new ATH) prior to correcting to the mean.
I know this doesn't seem super helpful, but its the only way that is a telltale sign that it doesn't intend on correcting. However, many of these cases where it went back to make a new high, it ended up crashing to the cubic and quartic mean some 1 to 2 months later :-/.
So where should we be looking to buy?
If you want to buy as a swing trade, I would wait to see if this is going to find support at one of the means.
If I wanted to buy as an investor with the long term vision in sight, then you can buy anywhere really. Stocks will only ever permanently go up and bear market cycles and mean corrections are just fleeting passings that are quickly absorbed into obscurity. I bet many of you forgot that we crashed in July ;).
Will it happen quicky?
The average Cubic correction takes about 1 week. In July I think it lasted about 2 weeks because those relentless dip buyers.
Hard to say but the historic average is 1 week.
How do we know if it will go lower?
In July, SPY went 1 point lower than the cubic mean and it was enough to make me, erroneously of course, call the end is nye. I was wrong obviously, because SPY quickly recovered. So I would say, hitting the general cubic range, even if it is below by 1 or 2 points, if it recovers there, that would be a good sign for a continuation up.
Summary
So kudos to you if you read this long!
Moral of this story is we should see a correction, likely greater than 5%, to the cubic mean. Remember the cubic mean is constantly increasing with each passing day, so we will need to be mindful of where it is and when contact is made.
For convenience, I will update with that information as we either completely reverse away from it or approach it.
Don't get too bearish, Cubic corrections are not usually a very bearish thing. Instead, they serve the purpose of providing buying opportunities for late entrants.
The economic situation of the US is right now uncertain until Trump takes presidency. Not sure of his economic plans, but in general he has stimulated economic growth. This would of course be good for markets.
Hopefully you found this informative. There were other things I wanted to discuss but I think this is enough for now.
Leave your questions below and safe trades everyone!
