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.
Source: Macro Trends
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.
Source: Advisor Perspective
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.
Source: Real Investment Advice
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.
Source: Sentiment Trader
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.
Editor, The Rum Rebellion