The Fat Lady Is in Fine Voice: There is Always a Pattern

Dear Reader,

In 1848, Richard Wagner began composing Der Ring des Nibelungen (The Ring of the Nibelung). It would take him a further 26 years to complete his epic operatic drama.

Der Ring des Nibelungen consists of four parts (cycles), performed over four nights.

In total, the performance lasts for 15 hours.

The story is based on German and Scandinavian myths.

The fourth cycle is Götterdämmerung (Twilight of the Gods).

In her farewell scene, the amply proportioned 19th century opera singer holds centre stage for around 20 minutes before the finale…the end of the world.

The audience knows that when the ‘fat lady’ starts to sing, the epic drama is all but over.

The US share market has been writing its own epic story for almost the same length of time.

The fat lady has taken centre stage at the New York Stock Exchange.

How many more minutes left in her 20-minute rendition is not yet known, but she is in full voice.

However, before showing you the market’s ‘musical’ score, this is something for you traders out there. My good friend and fellow editor Ryan Dinse has produced a video series ‘The Private Trader’s Edge’. It’s really good.

In the second video Ryan shows how his proprietary momentum indicator provides an uncanny level of guidance on the entry and exit points for randomly selected stocks. If ever there was a time for traders to have an edge it’s now. If you’re into trading, then sign up here to watch Ryan’s ‘Private Trader’s Edge’.

Back to the drama on Wall Street.

According to Open Learn’s ‘Understanding the principles of musical scores’…

It is often the rhythm patterns that articulate critical points in a musical score and can help our navigation and understanding of it.

The market’s musical score also has a rhythmic pattern.

In October 2009, market maestro, billionaire George Soros, wrote an article in The Financial Times about the two components that compose a bubble (emphasis added):

First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time.

Sometimes it’s quite insignificant, at other times, it is quite pronounced. When there is a significant divergence between market prices and the underlying reality, there is a lack of equilibrium conditions.

I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. 

When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. 

Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia.

That last paragraph sums up this market’s final 20 minutes on the stage.

Market expectations are so removed from reality. Doubts about the sustainability of disconnect. More people losing faith in its ability to remained divorced from reality.

Yet, the market remains suspended in this twilight zone…the S&P 500 Index has been going nowhere fast since the Fed turned the tap off on 10 June 2020.

Port Phillip Publishing

Source: Macro Trends

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Wagner’s Der Ring des Nibelungen consisted of four cycles.

The share market only has two. Up and down.

Eventually, everything is mean reverting

In the latest update from Advisor Perspectives on where the market cycle is currently at, they offered this rather succinct observation…

About the only certainty in the stock market is that, over the long haul, over performance turns into underperformance and vice versa.

The following chart is the musical score of the S&P 500 Index since 1870.

High notes followed by low notes.

Port Phillip Publishing

Source: Advisor Perspective

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In mathematical terms the further you move away from the mean — in either direction — you pass through ‘standard deviations’ left-hand scale (LHS).

On the upside, one standard deviation (SD) is not uncommon. Two standard deviations (2SD) is not all that common. But, 3SD…well that’s an absolute rarity.

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The US market is currently hitting a high note that’s almost on par with the peak of the dotcom mania…and we know that was followed by a very low note.

Eventually, everything is mean reverting…including the high-flying Nasdaq.

On 25 July 2020 Real Investment Advice provide this commentary on the graph below…

whenever the Nasdaq trades at 3-standard deviations above its 200-dma, prices always correct.

Most of the time, the corrections come very quickly. However, there are a few occasions where the payback was NOT immediate. Such lured investors into more risk before the reversion eventually came.

This chart has a lot going on, so I’ll try to simplify it for you.

The blue line is the Nasdaq Index. The red line is the Daily Moving Average (DMA)…a price momentum indicator.

The two shaded areas — green and pink — above and below the blue line are the areas of Standard Deviation.

When the Nasdaq (blue line) moves into the pink shaded area (or above) there is a rebound.

Port Phillip Publishing

Source: Real Investment Advice

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The extent of the rebound depends on whether the Nasdaq is building to a high — as it was during the 1990s — or whether it has reached a high…like it did in 2000.

The red boxed areas are market highs in 2000, 2007/08 and now.

The green squiggly line at the bottom of the chart is the moving average convergence/divergence indicator (MACD).

MACD indicates changes in the strength, direction, momentum, and duration of a trend.

The current reading is now well above the euphoric high that existed at the height of the dotcom boom.

The fat lady is in full voice

And now for the final rhythm pattern that articulates critical points in a musical score and can help our navigation and understanding of it.

In the moments before an epic bull market finale there is always a pattern…investors focus on those stocks that have done well and ignore the rest.

Port Phillip Publishing

Source: Sentiment Trader

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In the early to mid-stages of a bull market, the vast majority of stocks participate in the market’s rise.

However, after the upward trend is well established, the punters place greater bets on the market winners. Happens every time.

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The difference between Wagner’s musical score and Wall Street’s is there will be no encore performance.

When the curtains finally fall on the Dow Jones, S&P 500 and Nasdaq indices it will be a long, long time before we see anything on this scale again.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion