Possible Market Scenarios {The Bear}

I said last week that we'd look at some different market scenarios for the rest of the year.  We're going to examine the good, the bad and the toss-up scenarios this week.  Today we'll start by examining the bear case.  We'll look at what could go wrong.  We are looking at these mainly by using money flow analysis, trying to show you under each scenario what could happen.  At the end we'll give you the current probability that we see of this analysis occurring.  Please note that this is scenario analysis and not a prediction or guarantee that any of these events will occur.  It is possible that more than one of these events could occur or none of them might.  You should consult your own financial advisor or do your own research if you are not a client of our firm.  Better yet you can hire us.  In short if you use anything that you see here or over the next few days without some follow up then you're on your own.   

Charts are from TradingView.com.  Annotations are mine.

Before we do analysis, I think we should discuss the basic parameters you will see on each chart.

1.  Chart is of the S&P 500. 

2.  Basic chart is a weekly chart going back on the left side to 2013.  This is roughly from the period when the market last broke out from its prior level of consolidation.

3.  Arrows are meant to show basic movement over a certain period of time.  Green indicates bullish periods, blue indicates a period of indecisiveness and red indicates bearish periods.  They are meant to show generalized market activity over a certain period of time.  For the trading levels we show with these are approximate and do not show the normal backing and filling that should be expected on a daily basis.

4.  The large box in the top right hand corner shows on a valuation basis what we estimate could be the potential cone of probability for stocks out to the 2017-2018 period.  This is included solely for illustration purposes and to show what could be the market's potential outlook given what we currently know about the economy, sentiment valuation, etc going forward.  This, again, is here for illustrative purposes only.  These probabilities will most definitely be revised over the next several years.  Again there is no guarantee any of these probabilities will be met during the shown period.

5.  Horizontal lines represent significant levels of support/resistance.  The horizontal green line at the bottom of the chart represents  a significant level of support that dates back to the 2001 and 2007 market highs.  This was the line that was penetrated to the upside back in 2013 when this current rally phase of this bull market started.  The green horizontal line at the top represents the market highs we saw last summer.  The red line is the most current level of major support.  This line has been revisited many times in the past three years, most recently a few weeks ago.  The blue lines are intermediate levels of current resistance.

With that, let's get to the chart:

The bearish illustration for stocks looks something like this above.  After the initial decline we've seen this winter stocks stage a recovery into the spring with the potential to trade up to the resistance line in blue that's a bit over the 2,000 mark on the index.  There they hover in a period of indecisiveness in the early summer months.  A combination of perhaps election jitters, slowing economy or perhaps an event overseas sends markets in the late summer/ autumn period into another bout where risk assets are sold.  At some point in this example stocks penetrate that major support line in red.  That leads to a further sell-off, again perhaps exacerbated by more negative news.  

Where the market finally finds it's footing in this example would likely depend on how negative the news has become.  I have illustrated using three yellow shaded boxes, levels where the markets could possibly in this scenario trade towards.  Each of these boxes indicates areas in prior times where the market has found support or experienced congestion.  These levels that the market could trade towards and the probability of such an event occurring are based on our current understanding of events and are assigned below:

Support in the 1750-1800 level on the S&P 500 would mark a decline of 15-16% from our prior highs. It has a probability of occurring by our estimates of 20% based on our current understanding of events.

Support in the  1630-1680 level on the S&P 500 would mark a decline of 20-23% from our prior highs.  It has a probability of occurring by our estimates of slightly less than 15% based on our current understanding of events.

Support  somewhere around 1520-1575 on the S&P 500 would be a decline of 25-30% from our prior highs.  It has a probability of occurring by our current estimates of less than 10% based on our current understanding of events.  

These probabilities again are based on our current understanding of events.  We could raise or lower these numbers over the course of the year based on changes in the economy and changes in circumstances.  We will keep you apprised of our analysis going forward.

Now that I've given you perhaps a good case of the screams, we'll tomorrow look at a more optimistic scenario.  

*We are long ETFs related to this index although these positions can change at any time and without notice to readers of this blog.