CHARTS: Here's a timely reminder of the anatomy of really huge market crashes

US stocks have rallied back after the severe pullbacks of the previous two trading sessions.

Here’s a timely reminder on the structure of big crashes in history, in a note from Laurence Balanco and Jonathan Estrada at global brokerage CLSA.

To be clear, the analysts think we could be seeing the foundation for new all-time highs for US stocks. As you can see from the charts below, the really huge dives are preceded by a small sell-off and a recovery, before the main event.

CLSA

A small sell-off and recovery is exactly the point we are at now with US stocks and other global indices that are following their lead, including the ASX. However, Balanco and Estrada see what’s happened to US stocks as likely being a “tactical low” before a big resurgence over the next few months.

They say the process of a market topping out “typically generates distinctive warning signs which typically take the shape of divergence between price action and the indicators”, and US equities aren’t quite there yet — with the emphasis on yet, and we’ll get back to that.

They provide an extremely detailed roadmap in which the S&P500 would be expected to soar to the 3164-3638 region. Its Tuesday close was 2695.

They explain how their model sees this progressing:

  • A correction off the Jan high is playing out with the 200-day [moving average] providing support for the lows of this corrective pattern.
  • An advance to new highs with a 2,900-3,000 target zone.
  • From the 2,900-3,000 area, a deeper setback is expected to unfold, one that should be the largest since the late 2015 correction. Such a correction is likely to retarget the 2,400-2,483 area.
  • From here, we should see the final advance phase into the 3,164-3,638 area to complete the long-term uptrend sequence off the 2009 lows.
  • In conclusion, we would be looking for a tactical rebound off the 2,534-2,591 congestions zone which includes the October-November 2017 trading range as
    well as the 200-day MA. This rebound is likely to form part of the consolidation pattern that provides the platform for the advance to a new all-time high with the next time window for a more important peak in April/May.

Reminding us that a “top is a process”, they explain that tops are all about hope, “which dissipates diffusely”, as some people continue to buy dips expecting the trend to resume. “In contrast, stock market bottoms are often a concentrated point in time, as the emotion that drives a bear market is one of fear, which is sharp,” they write.

They offer this roadmap to the top of the S&P.

CLSA

They say (my emphasis) that their “conclusions … remain the same: the first is the extreme momentum and breadth readings in conjunction with rising volatility seen in January finally led to this sell-off. However, because our breadth indicators confirmed January highs, it implies that the rest of 2018 can only get more selective, which means that more and more sectors will roll over into underperformance before the overall market tops out.”

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