The Big Short 2.0 — The 2020 Crash is Not Over…
Two stock market crashes in one year? It’s 2020 what do you expect?
By: Charles Becco
Edited By: Baeli Smith
The notes herein were published through Brooklyn Traders LLc’s private newsletter to the organizations subscribers on September 10, 2020. You can see the original copy here. Through social media Brooklyn Traders has been calling for a correction or crash in the stock market since late July. The time has now come and the threat of a crash is at our very door. Whatever bounces we may experience between now and the inevitable crash below the March lows will be momentary. Any reprieve in selling should be ignored. In September, the market dropped so fast that it was the fastest 10% drop in market history. The sharp correction was led by a fallout in tech, Tesla fell nearly 20% and AAPL fell over 12% in 3 days. We believe the sell off in tech which began September 3rd denotes a shift in trend from bullish to bearish: from an expanding stock market to a contracting one. A copy of the original market note can be found here.
Price Extensions
The chart above is a monthly chart of the QQQ within the last 20 years. What’s important here is how far the monthly candles have left the ema’s (exponential moving average) the candles have never been so extended. But the last time the candles were proportionally extended this much was the 2000 tech bubble which was followed by a 5 year recession. At that time the QQQ was 218% above it’s 200 ema. In contrast, on September 3rd the QQQ was almost 275% above the 200 ema. That is a staggering proportion! In fact, anytime the averages get too far away from the ema we always revert back to the mean (34 ema) in the best case and under the 200 in the worst case. What’s even more interesting is that the 21 ema (8612 on Nasdaq) doesn’t even close all the (open) gaps that are fully closed somewhere in the 7000’s. But again since this is more like an asset bubble we may come all day way down to the 200 monthly ema which would represent a 60+ percent drop!
The chart above is a monthly chart of the QQQ. According to our analysis within the next 3 months we should have at least a 25% pullback (originally published in September, we have since pulled back 7%) in equities. In the worst case scenario, we will be going to that 200 monthly ema, ushering in a seismic ‘2000’ style crash. We believe this because not only is the price extended off the ema’s, we also have a partially bearish engulfing pattern. Even with the fed, gravity will take us at least back to the 8–21 the the 34 ema’s on the monthly time frame. As of today’s writing (10/30/20) The stock market has fallen 5% in less than a week and will close October bearish.
Bearish Engulfing Pattern
One of the most ominous signs of an impending collapse is the current bearish cloud that has encompassed QQQ’s on the monthly time frame. The bearish cloud denotes a strong shift in sentiment and price trend from bullish to bearish. Within the last 20 years, a bearish cloud print shortly after an all time high print on the monthly time frame has usually preceded a crash or sharp sell off to at least the 34 ema in the best scenarios but more often a crash below to 200 ema on the monthly time frame, the worst being a 78% pullback after the 2000 Stock Market Crash.
Within the last 20 years there were 4 instances where such a candlestick pattern emerged. The first pattern emerged in March of 2000, when Japan entered into a recession and Yahoo and eBay discontinued merger talks.
The second time a bearish cloud printed out during a monthly time frame was in the 2008 Stock Market Crash where a cascading banking/ financial crisis saw the liquidation of bear sterns, Lehman brothers and a systematic failure of world wide financial markets.
The third time this happened was in October of 2018 that came as a result of increasing tension between a trade war between the U.S and China and an inflated market that tripled since the previous ‘great recession’ in 2008.
The fourth time this happened was in February of 2020 (2020 Stock Market Crash) after the Coronavirus, which paralyzed the entire world’s economies, landed stateside in the United States which was ill equipped to deal with this pandemic. The virus doused a dizzying market which printed new high on almost a daily basis. The markets experienced a steep incline in valuations brought mostly by a low interest rate environment and tax cuts that resulted in billions of dollars or stock repurchases.
So where are we and where are we going?
To answer the question above we must identify and evaluate 4 unique Market Phases.
Phase 1 is called an accumulation phase. Usually an accumulation phase follows a mark down phase but sometimes it comes after a mark up phase while the chart cools off and consolidates. The accumulation phase is typified by side ways or choppy action within a well defined trading channel. What’s happening behind the scenes is that hedge funds and banks are buying positions while no one is looking. Usually the sentiment is mildly bearish/ neutral. Oftentimes financial pundits will recommend you avoid tickers with this style of action.
Phase 2 is called Markup. Usually a markup phase follows an accumulation phase and at times, although rare, a markdown phase. The phase is typified by a sharp bullish uptrend that is uniformed with few interruptions. Usually the sentiment is overwhelmingly bullish. The markup phase is powered by continued buying by institutional investors along with early adopters and long time holders. Oftentimes the press begins to soften their stance on the ticker, maybe even become cautiously optimistic.
Phase 3 is called Distribution. Usually a distribution phase follows a markup phase and can be confused with an accumulation phase. The phase is typified by a choppy sideways action but with a twist , there will be descending highs or lower highs. Oftentimes the press will praise the accolades of a stock while the masses jump over each other to “buy the dip” of cheap shares that will surely rise “like it always does.” During this phase hedge funds are closing out their positions and institutional investors are unloading their shares on unsuspecting main street/public investors or “dumb money.”
Phase 4 is called a Mark Down Phase. A markdown phase follows a distribution phase. The phase is typified by a sharp relentless drop in price brought on by large positions exiting the market all at once. Hedge Funds and institutional buyers would’ve long closed their position. What’s left is an unending cycle of public investors ‘buying the dip’ then being overwhelmed by other public/main, “dumb money” traders who brought the dip at a higher price and are selling their shares to you because their stops or max pain levels were reached. The public sentiment will be overwhelmingly bearish and financial news anchors will ask on an almost daily basis “when and where will the bottom be?”
So where are we? Below are two charts. The chart to the left contains technical notes showing an increased likelihood that we are on the precipice of a precipitous price fall. The chart on the right shows a textbook trading psychology market cycle. When placed side by side the parallels are unquestionable. We are looking at a textbook market correction to the downside that we believe will cause a cascading price reduction and an eventual crash.
On January 3rd, 2020 I wrote “Why the 2020 Stock Market Could Blow Up your 401k.” The article outlined the exact reasons why a crash would come. In less than a month the crash happened
The underlying causes that resulted in the previous crash have only been abrogated by Covid-19 which saw trillions in cash dilution and a euphoric market that made amateurs into millionaires in a matter of months. “The end is near” is the phrase usually hung up on a sign as a warning of things to come. Not only is the end near, it is at the very door. Do yourself (and your portfolio a favor) by trimming or severely reducing your market exposure. Allocate your 401k,IRA, and or retirement into a defensive portfolio or money market. Hedge the market with gold, silver, and treasury bonds. Hug your kids, live a good life and do NOT make any major asset purchases! Charles Becco and Brooklyn Traders Forbids You!