Does History Repeat? Two Charts That Should Have You Concerned

history repeating

There’s a saying most of you have probably heard before:

History never repeats, but it often rhymes”.

With all the commotion in global markets over the past week or so, I got thinking about previous periods of panic and high volatility. After all, market moves reflect changes in sentiment based on the herd mentality of the human population. As far as I can tell, people are still people – they still behave in much the same way they did 5, 10 even 100 years ago.

Was there anything I could learn from looking at data from past market crashes that could provide some clues? Does the current situation look similar to technical patterns we’ve seen in the past?

I didn’t have to look far, and what I found was rather scary…

Two Charts, Two Very…Very Similar Looking Setups

Below is a chart of the Dow Jones Industrial Average from early 2002. What you see is a period in time during which the Dow experienced a very strong, 5.5 year bull market.

Note that the final candle shows that during the month, the index broke below it’s long term trend line, albeit bouncing back hard to close the month well above the trend line.

Dow monthly chart

Chart 1: Monthly chart of the Dow Jones Industrial Average, directly preceding the Global Financial Crisis (GFC).

Now lots look at a second chart. This time, looking at the current state of play.

The chart below shows how the Dow has performed since mid 2009 at the very low point following the GFC. It doesn’t take much imagination to realize there are a lot of similarities between the two…

Dow monthly chart

Chart 2: Current monthly chart of the Dow Jones Industrial Average, as at 28th of August, 2015

Firstly, both charts show very strong bull runs lasting a similar amount of time (5.5 to 6 years). Second of all (and most compelling) is the almost identical nature of the break below the long term trend line.

The GFC – How the 5.5 Year Bull Run Came To An End

Back to Chart 1, most of you would know how that ended up playing out, but for those that don’t, the chart below show’s exactly what followed:

Dow GFC chart

Monthly chart of the Dow Jones Industrial Average showing the lead up to, and subsequent decline during the GFC.

The chart above shows some pretty text book behavior as far as technical analysis goes, and gave off many signals that a wide spread sell off was, at the very least, a high probability.

For those without a trained eye for such things, I’ll explain my take on proceedings below along using an annotated version of the chart. The numbers on the chart correspond to the bullet points below it:

Dow GFC trading

A closer look at the “technicals” of the Dow Jones Industrial Average during the GFC panic.

1.The Dow begins to “roll over”, indicating short term selling/profit taking.

2. The index breaks below its long term trend line for the first time in 5.5 years, putting in a very wide spread down candle. Buying comes in, as would be expected during the testing of long term support (the trend line), and the candle closes towards the upper middle of it’s trading range.

3. The index then goes through four months (as shown in the next four candles) of indecisive trading, struggling to stay above that long term trend line. You’ll notice all trading during these months happens within the spread of the candle that initially broke down through the long term trend – this is significant as it shows the market was “testing” this region of previous heavy supply. This period represents the real battle the bulls and the bears – between those that think the bull market will resume itself, and those that think a bear market is nigh.

4. We see a secondary, sustained break of the trend line, but this time the bulls are exhausted and there is no buying support, as shown by the candle closing at it’s very low (below the trend line). Note the close below the range of the initial trend breaking candle shown in point 2. The bulls are nearing capitulation.

5. Time for one last ill faced rally, as the last of the bulls becomes exhausted. Buying is weak and is always met by selling, as shown by closes in the mid to lower and each months range. Note that, price never closes above the the low of the range shown in point 2.

6. Capitulation begins and the bears take full control. Selling is relentless and price begins to fall rapidly.

7. The GFC is in full swing. From peak to trough, the Dow ends up losing over 50% of it’s value, and closes lower than it’s November 2002 low, wiping out over five years of gains in the process.

What Can We Take From The GFC Experience?

Referring to the quote at the start of the post – “history never repeats, but it often rhymes”. Blind Freddy can see the similarity between the technical setup back in 2006-07 and today. Does That mean we are sitting on a cliff, about to experience the next financial Armageddon?

Absolutely not, and as I stated in my last blog post, there’s actually plenty of fundamental reasons why the global economy isn’t as gloomy as many would have you think. To top that off, since that post, U.S. second quarter GDP growth was revised upwards from 2.3% to a whopping 3.7%!

For those that don’t follow GDP numbers, that is a very, very healthy rate of growth. It appears as though, for the moment at least, the U.S. economy is gathering steam.

Everyone is hoping that the U.S. can return to the growth powerhouse it once was, so that it can take over the slack from the slowing Chinese juggernaut.

I know, I know, we’ve been hearing this for the past 6 years, and there’s a little bit of “the boy who cried wolf” syndrome in my thinking too. I can’t help but be skeptical considering growth has never reached the “escape velocity” we were all promised from loose monetary policy in the form of ZIRP and QE.

QE

But, this is a post about the technical side of things, so I won’t get into an in depth discussion on the fundamentals of the global economy, other than to say there are a plethora of things that are different this time.

From technical a technical point of view, all we need to take from the current situation is that we are seeing similar signs to those which preceded the 2007-08 crash. Nothing more, nothing less. These signs include:

  • The beginnings of a heightened level of volatility (since my last post, the VIX has moved to it’s highest level since 2009!).
  • Signs of technical weakness in the background, as shown by the rounded top.
  • Many longer time frame technical indicators turning down (see the Money Flow indicator in the chart below).
  • Breaking of a significant long term trend line for the first time in years.
VIX chart

The VIX – an index measuring market volatility, has moved in a single week to it’s highest level since that seen directly prior to the GFC

These are all technical signs which preceded the GFC crash, and are definitely reasons for extra vigilance in the short to medium term.

Monthly Dow Chart

Monthly chart of the Dow Jones Industrial Average showing the entire 2000’s bull market run, the GFC crash and the current bull market run.

Where To From Here? What To Look For In The Coming Months

I know in my previous post I suggested I wasn’t overly concerned (yet) about a near term market crash. Well the very next day saw that 1000 point spread day on the Dow, where for the first time in 6 years, the long term bull trend was broken (how’s that for timing).

I’m no doomsayer, and to be honest, I’m still not panicking. In saying that, my thinking has probably moved more towards a 50-50 chance of a major correction compared to just last week, where I was firmly in the camp that a correction was less likely.

The main reason for this change was the break through that powerfully strong trend line. Those kind of trend breaks don’t happen very often.

It’s hard to know whether the sell off was triggered by something sinister like a faltering global economy (China is definitely in trouble, at least in the short to mid term), or simply the result of profit taking after a good run.

Another thing that almost certainly contributed to the ferocity of the sell off is the effect of algorithmic trading which dominates world trading activity nowadays. A break through certain key levels like a long term trend line would undoubtedly have triggered a sell signal in many of these algorithms. Many retail traders would have had a traditional stop loss at these key levels also, exacerbating the sell down

algo

Regardless of the reasons, the GFC crash provides us with a template for what “might eventuate”. It’s given us things to look out for whenever these kinds of technical setups present themselves.

So what am I looking at over the next few months?

I believe the trading range from this month is going to be key in terms of where this market heads. If, as in 2008, the Dow doesn’t break above this months high, then things are looking a little dicey. Also, the longer the market hovers around within August’s trading range, the higher the chance of a move lower, in my humble opinion.

Conversely, if we see a sustained move above this months trading range and on to new highs, then it seems likely that this months panic sell off was just that – unwarranted panic from nervous Nellies worried about a China sell down, among other things.

We now have a very important trading range for which to obtain clues regarding likely future direction. I will be watching closely to see how the market trades this recent key range over the coming months.

Dow Jones Future Prediction

Monthly chart of the Dow showing the important levels in the coming months.

It’s also important to note that throughout this post I’ve only shown charts from the Dow Jones Industrial Average. Other key U.S. indices like the S&P500 and the Nasdaq haven’t broken long term trend lines (at least yet).

I personally like the Dow, primarily because it’s made of up industrial related companies which I feel give the best representation of the “real” economy. But all U.S. indices, as well as other key global indices such as Germanys DAX, the Nikkei in Japan, the ASX in Australia etc. are certainly worth keeping an eye on as well.

If the breaking of long term trend lines becomes more of a wide spread (and global) phenomenon, then it’s time to really start getting worried.

To Conclude

Over the past week, things have deteriorated to the point where I’m now equally as worried about a global sell off as I am bullish about a continuation of the great bull market run.

The technical picture shows that, with the Dow at least, we’ve broken a key long term up trend for the first time in over six years. To compound things, the current technical setup has uncanny similarities to the period in time directly preceding the GFC crash.

A break of a long term trend is a powerful “caution required” signal, and if you weren’t already, one would be foolish not to pay close attention to markets over the coming few months. I’m hoping history doesn’t “repeat” itself in this instance.

I’ll be watching closely to see how markets trade within the wide trading range seen across global markets in August. Here’s to hoping we see a strong breakout above to new highs and not another global financial meltdown circa 2008-09.

Happy Investing,

The Nude Investor

I’m interested to hear your thoughts – what do you think about the current state of play? Are we about to see the next global financial melt down? Or is this just a temporary bout of volatility before we resume to bull trend? Comment below or flick me an email!