Why last week’s drop didn’t change anything

Stock markets went into a steep slide last week, producing one of the worst starts to a new year ever. I wrote last week that the shorter term indications tend to pan out first, and that’s what we are getting. This gives us a new situation in the Nasdaq chart (click image to enlarge it):

The drop has cut through several support levels in the Nasdaq, and the next one is just below 4600, the late September lows, as well as the support zone that held the market in early 2015. Whether stocks will go that low remains to be seen. A failure to test the 4550-4600 zone would actually be a bullish sign.
Technically all my indicators are now heading for major lows, but showing no signs of bottoming out just yet. It may take another week before they start turning up again, so there is good reason to remain patient and wait for signs of stabilization. Sometimes selling begets more selling and creates a chain reaction. That possibility is definitely on the table at this point.
It looks like the market is going with the LT wave for January, which points to ongoing weakness until around the 19th. We will also start a new lunar red period later this week. So, I would stay patient and wait for clearer signs of a bottom. Even though we are likely to get some strong up days this week, they always come after a slide like this, another dip or a retest for a double bottom is a strong possibility in the third of week of this month.

The terrible start of the year revives talk about a market crash or a recession in 2016. But this drop didn’t really change anything for people who keep a birds eye view on the market. The most simple approach to investing doesn’t use any indicators and just goes along with what can be seen on a long term chart. If a stock or index keeps setting new highs regularly and just shows an ongoing pattern of higher highs and higher lows on a weekly chart then it is a bull market. Conversely if it keeps dropping to lower lows followed by lower highs it is a bear market (see Oil for a perfect example). Simple enough. There is a third “in between” state when we can question the state of the market. E.g. when we have a lower high and a higher low, then we don’t know if the market is bullish or bearish.
If we look at a weekly chart for S&P 500, the “regime changes” are easy to spot (click image to enlarge it):

From 2012 until well into 2014 it was a classic bull market, just higher highs and higher lows persistently. To be considered a lower low I always look for a low that is below the most recent visible low that came at least two to three months before. I want the low to stand out from the chart. So, just being down for three or four weeks does not make for a good lower low on this time scale.
The ebola panic in Sep-Oct 2014 gave us a clear lower low for the first time in years, but it wasn’t followed up by a lower high, so the bull market just continued with the market climbing to new highs.
Then we got the recent drop in August 2015. It was the biggest pullback in years, but it was not a lower low because it kept well above the previous significant low. We did get a nice lower high in November and that means we are now in “in between” state. If the market goes on to drop below the Aug 2015 lows, then we will have the regime change to a bear market. But if the market goes on to climb above the Nov 2015 high, then it is just an ongoing bull market. And that’s why last week’s drop didn’t really change anything. We have been in “in between” state for a while already and that situation remains unresolved until we get a breakout either way. A lot of people are of course forecasting that the market will crash. Trying to forecast what will happen can be fun, but it also can be costly. Some market “gurus” have never stopped forecasting the next crash since 2010. The followers who listened to them probably have no money left to trade by the time one of their forecasts inevitably comes true.
A 30% or more bear market historically happens about once every 10 years. But as my uncle used to say: “the best way to protect yourself against a crash is by participating in the bull market that comes before it.” If the market falls below last August lows, then it becomes a different ball game. Until then we just don’t know.