As of late, I feel a bit like The Boy Who Cried Wolf while highlighting various technical developments that have historically lead to corrections in the stock market such as trading volumes falling to extreme low levels, negative divergences that continue to build, etc… yet the market continued to hold up. Some say this time it’s different because __________ (fill in the blank: market intervention by the Fed, zero interest rates forcing bond investors to buy dividend stocks, corporate share buybacks, etc…) Of course, we all know how Aesop’s famous fable ended.
SPY Bollinger Bands Width 8-22-16
While the vigor of the rally off the June 27th lows and more recently, the resiliency of the near-sideways trading range/refusal of stocks to move lower over the last month just can’t be denied, neither can the fact that those same warning signs that have historically preceded corrections in stock price have not abated, rather continue to build. As this 7-year chart of SPY (S&P 500 tracking ETF) highlights, every time the Bollinger Bands have pinched to such extreme levels (as defined by the blue horizontal line on the BB Width window at the bottom of the chart), corrections in the %5+ range nearly immediately ensued.
Could this time be different? Certainly, as anything is possible. However, this recent development, along with some of the other extremes highlighted here in recent weeks, simply means that the probability of a substantial pullback in the market is very much elevated at this time, despite what appears to be an extremely resilient trend. As such, long-side breakouts face an increased rate of failure and/or falling shy of their measured price targets while the risk of a potentially swift selloff, especially given the proper catalyst, remains elevated at this time.