What A "Blow-Off" Looks/Feels Like

The title of yesterday's missive was "The Blow-Off Stage?". The suggestion was given that the dominant color on my favorite models/indicator boards relating to the stock market's trend and momentum is green, it could be possible that we are seeing what is termed a "blow-off" phase.

However, it occurred to me that not everyone reading my oftentimes meandering morning market missive might be familiar with the term. So, this morning, I thought we'd review what a "blow-off" phase looks and feels like. And then I'll throw in a few stats, just to keep it interesting.

In general, a "blow-off" phase tends to mark the end of a cyclical bull phase. To review, the database at Ned Davis Research tells us that the cyclical bull moves in the stock market (defined as an increase in the DJIA of at least 30% after 50 calendar days - or a gain of 13% over a period of at least 155 days) since 1900 have produced an average gain of 85.5% over 768 days.

However, as logic would dictate, cyclical uptrends that occur when the stock market is in the midst of a secular bull run (note that several cyclical moves tend to occur within secular moves, which tend to last many years) tend to be longer and stronger. For example, the average gain for cyclical bull markets that occur within secular bulls since 1900 has been 106.7% over 1027 days.

To be sure, identifying a blow-off stage is best done with a healthy dose of hindsight. As such, anyone trying to suggest that such a move is occurring in real time is likely "making a call." And to clarify, I am not suggesting that what we are seeing IS, in fact, a blow-off phase. No, I am merely trying to alert everyone to the idea that we COULD be seeing such a move here. (Or not!)

I've witnessed a grand total of 10 blow-offs during my career, which began in 1980. There were 3 in the 1980's, 3 in the 1990's, 4 in the 2000's (well, to be fair, the blow-off that ended in January 2000 should probably be placed in the 1990's category as it was a doozie!), and 1 so far in the decade that began in 2010.

The first thing to recognize here is that we haven't seen a blow-off phase since April 2011. So, it's been awhile.

Next, blow-offs tend to be characterized by an overly bullish mood (if not euphoric) from a sentiment standpoint. By the time stocks make their final run during what amounts to a fairly long bull cycle, just about everybody in the game understands and can recite the bull case. I.E. everybody "knows" the reasons that stocks are going to continue to go up. The term "no brainer" tend to get used a lot during the blow-off phase.

Earnings are growing. The economy is humming along. And something is happening to cause investors to think that risk in the stock market is an antiquated concept. (In this case, I'll argue that the "something that is happening" is a combination of QE and tax reform.)

And finally, there is a little something called capitulation. This is where fund managers who may have been concerned about risk factors in the market (valuations come to mind on this front here) simply give up. Performance anxiety sets in as year-end bonuses are on the line. So, managers simply throw up their hands and jump on the bull band wagon.

The Average Blow-Off...

As for what to expect from a statistical standpoint, Ned Davis himself published a report this week that shed some light on what the blow-off phase has looked like.

However, the first point the venerable Mr. Davis makes is that his table of "blow-offs" is "too subjective for my taste." Ned says that (a) there have been many instances where a big rally doesn't actually wind up being the final rally of the cyclical trend and (b) the starting dates of the final moves can vary depending on who is making the call and the criteria they are using.

With these caveats out of the way, I find it interesting to note that since 1960, NDR has identified 13 blow-off phase rallies that marked the end of cyclical bull moves. The average gain on the DJIA during these moves has been 12.7%. And the average duration of the rally has been 58 trading days.

Ned also points out that IF we are seeing a blow-off at the present time, the move likely began on August 18th with the Dow closing at 21,674.51. The high of this move occurred a week ago at 23,441.76, putting the gain for the current move at 8.15% on the Dow (which has been the strongest index of late).

So, based on history, if the DJIA winds up putting in an average blow-off move (trust me, it won't), the Dow could add another 4.55% - putting the high at 24,509.

For anyone thinking that the next bear market is going to look a lot like 2008 (I doubt it), you are probably thinking that it might be best to exit stage left now. Why not skip that last little leg and save yourself the pain of the ensuing bear, right?

The problems with this thinking include (a) we don't know if this is indeed a blow-off stage, (b) the stock market has a strong upward bias over time, (c) the final moves in bull markets vary greatly, and (d) in my experience, the final move tends to last longer than anyone can possibly imagine.

It is for this reason, the I prefer to avoid "making a call" and suggesting that I know what is going to happen next. No, I prefer to deal with what "IS" happening in the market and adapt when necessary. And the bottom line right now is the bulls are in control of the game. So until some of our market models start to wave red flags, its a bull market until proven otherwise and the dips should continue to be bought.

Thought For The Day:

Well-timed silence hath more eloquence than speech. -Martin Farquhar Tupper

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

1. The State of Tax Reform

2. The State of the Earnings Season

3. The State of Fed Policy/Leadership

4. The State of the Economy

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.


The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

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Posted to State of the Markets on Nov 01, 2017 — 9:11 AM
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