Phases of the Stock Market

There are 3 primary phases of the stock market.  

1.  Low Volatility Uptrend

2.  Volatile Choppy Topping

3.  Volatile Downtrend

The market spends most of its time in 2 of 3 phases:  low volatility uptrend and volatile choppy topping phase.  Since the elimination of the gold standard and the emergence of the Fed put and corporate welfare government policies, the volatile downtrend phase of the market has been getting shorter and shorter.  The volatile downtrends are the hardest to trade for most because they are so uncommon and because most are losing money and trading from behind, with fear the primary emotional driver.

Looking at the big picture provides a guide to how to trade the shorter time frames.  In a low volatility uptrend, you want to stay long and minimize trading.  Buy and hold strategy works the best here.  A look at the past SPX charts give you a good idea of what the low volatility uptrend phase and volatile choppy consolidation phase look like. 

SPX 1997 to 2001

The SPX was in a low volatility uptrend from 1995 to 1998, and 1999 was a transition from low volatility uptrend to volatile choppy top formation.  The uptrend in the 1990s was so strong and long lasting that it took over 15 months of choppy consolidation before the market entered a downtrend and a long bear market.  Usually the longer the uptrend and the higher the valuations get, the longer the bear market happens as a result.  It looks like that's what's going to be in the cards for SPX in 2022-2023.  

 

SPX 2005 to 2008

You can see another low volatility uptrend leading to a volatile topping phase above.  This time, the topping phase was shorter than 2000 as there wasn't as much of a built in bullish bias in 2007 as there was in 2000, thus taking less time to change the market psychology and trend.  The sudden drop in February 2007 was a canary in the coalmine warning that the topping phase was soon coming. 

 

SPX 2013 to 2016

After the fiscal cliff was resolved at the end of 2012, you had a relentless rally for 3 years until the end of 2014.  The sharp drop in October 2014 was the canary in the coalmine warning of the topping phase to come in 2015. 
 

SPX 2016 to 2018

 After the correction in 2015-2016 was completed in February, you had a low volatility uptrend until the end of 2017.  The market went up in a parabola in January 2018 which immediately resulted in a sharp drop after making the top.  This time, there was a no canary in the coalmine, although the parabolic move higher was unsustainable and probably about the biggest warning sign you can get after such a steady long uptrend.  The volatile choppy topping phase started with a bang in February, and ultimately with Powell's dovish pivot in January 2019, you cut off a potential bear market right at the knees, much like what you saw in March 2020.  

 

SPX 2020 to 2021

 This brings us to the current market, which is a textbook example of a low volatility uptrend.  No parabolic rise like January 2018, no sudden big drop like in February 2007 or October 2014.  There are no warning signs of a top, which means we are likely to go much higher before we get to the volatile choppy topping phase.  Monetary policy is also very loose, and will stay that way for at least another year.  The tops in 2000, 2007, and 2018 were all preceded by a rate hiking cycle that took rates higher than the economy could handle over the long term.  We aren't even close to that yet.  But other than Fed policy, the two most important signs of an impending top for next year are there:  

1. Record high valuations.

2. Rampant speculation.  (Bitcoin, small cap pump and dumps, meme stocks, NFTs, sports cards, etc.)

This uptrend phase likely lasts into the end of the year, and then 2022 will set up like 2000, 2007, and 2018 for a volatile choppy topping formation.   This market cannot handle rate hikes, which probably means that even if Powell tries to start hiking, he won't get very far before the stock vigilantes force his hand and make him stop the rate hike cycle and force him to restart QE and likely, equity ETF purchases if we get a bear market. 

Nothing new on stocks or bonds, SPX keeps hitting all time highs, bonds trading in a tight range.  Seasonally weak period coming up, but there are no guarantees of weakness in an uptrend phase like this, but if it were to happen this year, September is probably the best chance for one.  SPX at 4400 would now be considered a generational buying opportunity to get on the moving bus.