75% Chance of Recession

03/17/2020 10:07 am EST

Focus: TECHNICAL

Al Brooks, MD

Professional Trader, Author, Lecturer, Brooks Price Action, LLC and Brooks Trading Course

With continued market weakness we are now officially in a bear market with a recession on the way. The main question is whether this is a cyclical bear or a secular bear. Al Brooks describes the difference.

Yesterday we provide a broad technical analysis of last week’s price action in the E-mini S&P 500. Here we dig down and explore the likelihood of a recession.

There have been unusually extreme buy climaxes on the daily, weekly and monthly charts over the past two years. These patterns have led to write over the past several months that there was a 75% chance of a recession in 2020.

Rarely is anything that certain in the financial world. However, many businesses are greatly reducing their services. Travel is the most obvious example. Also, when the value of stocks fall this much, wealth is lost and consumption goes down. That ripples through the economy and causes layoffs and a further reduction in consumption. I now believe that the odds of a recession are at least 75%. I suspect closer to 100%.

Coronavirus is not the problem

The media are blaming Coronavirus, but that is because they are in the news business. They believe that everything important is caused by something in the news. The sun revolves around them. They are the center of the universe.

If this bear trend is due to Coronavirus, why is it that two years ago, I repeatedly said that the E-mini would enter a 10-year trading range within a few years? I said that because the 2017 buy climax was the most extreme in history. It was strong enough to have at least a small second leg up, but it was likely to be the start of a major top. The 2019 buy climax completed that top.

Therefore, you can think of the past two years as investors building a bomb in the market. Coronavirus hit the switch and it blew everything up. But it was going to blow up anyway. If there was no pandemic, some other black swan would have come along and triggered the explosion.

Most extreme buy climax in history

As I mentioned above, I said two years ago that the market was forming the most extreme buy climax in history. Furthermore, I repeatedly compared it to the rallies in the 1960’s and late 1990’s. Also, I said that both led to trading ranges over the next 10 years and traders should expect the same this time.

In a couple years, Coronavirus will no longer be in the news. So why won’t the bull trend resume? Why not in five years? Is it still Coronavirus? Of course not. Extreme buy climaxes need a long time to resolve. It will probably take about a decade.

In a couple years, you will no longer hear about Coronavirus on the business news stations. If the market is still sideways to down, you instead will hear about how the stock market was not generating the earnings that traders expected in 2019 and 2020. You will also hear that the market was propped up by the Federal Reserve and incredible borrowing. In fact, those are the real reasons for this bear market. I suspect that it will be much longer than a few years for them to go away. They will be here long after Coronavirus is gone, and therefore Coronavirus was the temporary excuse, but not the underlying long-term problem.

Is this a secular or cyclical bear market?

These are other terms that you will sometimes hear. The simplest distinction is that a cyclical bear trend is shorter term, lasting one to three years. It is a pullback in a secular trend.

A secular trend lasts many years or even a decade. It typically contains one or more cyclical trends up and down within it, but the underlying force behind the secular trend remains intact.

When a selloff falls about 20% and lasts about a year, traders call it a cyclical bear market. The implication is that it is just a protracted pullback in a much bigger bull trend.

If the market falls 40%, traders will start to refer to the selloff as a secular bear trend or market. Remember, “trend” refers to the chart pattern and bear “market” refers to a loss of more than 20% from the all-time high. When there is a bear market, the daily chart is usually in a bear trend.

In a secular bear market, there are cyclical bull trends. Their average gain is about 65%, but they end in about 18 months, and then there is another swing down.

Since I believe that the market will be sideways for about a decade, the 12-year secular bull market is probably ending. If the market goes sideways for a few years, traders will begin to refer to it as being a secular bear market. They will then assume that any rally will fail to get much above the old high.

World economic forces might be turning bearish

The charts are indicating that the world’s economic forces are transitioning into a bearish mode from the bullish mode of the past 12 years. This is impossible to know for certain for at least a few years, but that is what happened in the 1970’s and the 2000’s. Both decade-long trading ranges followed huge bull trends. Price got far ahead of the fundamentals. It took about a decade for the fundamentals to catch up.

There has been a secular bull trend since 2009. If there is now a secular bear market, the bearish forces will probably control the market for about a decade. Those forces will eventually overwhelm everyone to two-year strong rally.

While there might be one or more brief new highs over the coming decade, if this is in fact a secular bear trend, the market will probably be unable to go far above prior highs. Furthermore, it will probably fail to stay above there for very long.

Buying opportunity for retirement Account? NO!

A friend of mine told me he sees this selloff as another great buying opportunity for his retirement account, just like every other selloff for the past 12 years. He said he bought last week when the market was 10% down. I told him that I have been saying that every selloff for the past 12 years was minor. So yes, even a 10% reversal was likely to resume up to a new high. The market was in a secular bull trend. Every selloff was a buy because a new high was likely.

But the market is now a bear market. And it might become a secular bear trend. This is different from everything that has taken place for 12 years. You cannot trade it the way you have been trading. This is not the time to buy unless you are a trader looking for occasional bear rallies. Even then, you will lose money if you do not know how to manage your trades.

Even if this turns out to be a routine bear market (cyclical bear), the low is still likely to be many months to a year away. There is no need for investors to buy now. They might be able to buy lower in about a year.

Also, it typically takes about a year before there is a test of the high after a bear market begins. Consequently, there is no rush to buy.

Finally, if I am right and the market will be in a trading range for 10 years, investors will be frustrated by their lack of returns. Traders waiting to buy 30% to 50% pullbacks and then take profits on rallies of about 50% will probably do better than buy and hold investors over the next decade.

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