What do Markets do after Capitulation?

Both Bulls and Bears see RED

In a week that built news momentum Friday’s concerned Jackson hole speeches from central bankers and the escalation of the trade war will ensure traders look to next week nervously rather than dwell on the events of last week. It is almost easy now to forget the Italian government fell and US Manufacturing PMIs produced the first contraction in a decade. And yet with so much political and economic uncertainty, following China’s announcement of $78bn retaliatory tariffs and Trump’s retaliatpry tariffs, history is a much better guide to what markets will do from here than second guessing what world leaders may or may not do even at this weekend’s G7 meeting in Biarritz.

In last week’s newsletter, perhaps now  with a sense of foresight and irony we explained how SCARED traders and investors will continue to produce different versions of markets into 2020.


A nervous market remains Subverted by spontaneous news producing often unsustained moves. Friday was a perfect example. The bearish impact of Chinese tariffs was classically unwound by the anticipation of hope from Powell’s Jackson Hole speech.

This enabled us not only to stay heavily short risk (2932 SPX 26250 DJIA NDX 7852 DAX 11787 average USDJPY 106.90 and WTI 57.05)

But it also allowed us to hedge before Powell and resell NDX 86 points higher on the unsustained relief rally prompted by his speech.

In his Jackson Hole speech the Fed chair said little that was new and suggested they remain concerned about the global and therefore US economy

"The three weeks since our July FOMC meeting have been eventful, beginning with the announcement of new tariffs on imports from China. We have seen further evidence of a global slowdown, notably in Germany and China. Geopolitical events have been much in the news, including the growing possibility of a hard Brexit, rising tensions in Hong Kong, and the dissolution of the Italian government."

Whether these fears will be Converted into economic reality remains to be seen. But it is curious how a previous data-dependent Fed is now almost fear-dependent.

“Financial markets have reacted strongly to this complex, turbulent picture. Equity markets have been volatile. Long-term bond rates around the world have moved down sharply to near post-crisis lows.”

It is almost as if the Fed is now following President Trump’s lead of using the DJIA as a barometer of the US economy which,  despite all, “continued to perform well overall, driven by consumer spending”. Job creation has slowed from last year's pace but is still above overall labor force growth. Inflation seems to be moving up closer to 2 percent.”

How markets Convert fear and deteriorating economic indicators into price would appear to be increasingly important possibly moreso than the much-discussed yield curve. The history of a yield curve inversion, as we pointed out previously, more often than not does not lead to risk Aversion. And yet after Powell’s speech the market sold off heavily to reflect the escalating trade war concerns. As the sell off accelerated into the close, we reduced shorts and hedged our remaining positions (with the exception of our AAPL puts and DAX and our EURUSD long). Why? Partly because of the standard reaction to negative tariff news.

And partly due to the unknown risks from this weekend’s G7 meeting and the possibility that non G7 member China announced tariffs as a bargaining chip to encourage G7 to facilitate a truce permanent or otherwise. The timing cannot have been coincidental.

However, the main driving force behind a very clear trading strategy for the weeks ahead is that we expect markets will continue to see RED.


Markets tend to react in a similar way after capitulations, like we saw following the US rate cut at the end of July, and is likely to be a useful guide this week as it has been the last few weeks.

The first thing they tend to do is Reversion to means. In other words recover by unwinding the excessiveness of the capitulation frequently sharply, at least initially, to the point of the last extension in the decline ie 2930 in SPX. We started to see signs of this on Friday’s close with a leading Oil that recovered thankfully after we closed our short just ahead of our 53.20 target.

What markets do after this reversion to mean depends on a number of factors. For example December’s aggressive capitulation was in many ways an outlier move not just because it screwed our 1987 and 1929 (final) corrective template but also because it happened at a time of low liquidity when many players refused to get involved. The result was a sustained uptrend until May. However normally the market settles between the capitulation low (2772.7) and approximately the point of the extension (2932).

This can be seen as an Eversion where markets turn themselves inside out in a nervous whippy consolidation as the bull – bear debate rages between ‘it’s a correction’ or the “first leg of a larger move”. In this respect the projected two way volatility we have seen in August is not only typical it actually means little except an opportunity to trade violent swings. This nervous sentiment driven market  however eventually also leads to another Eversion where markets rotate outwards. In other words they expand and break the range at least to give the impression the debate is resolved and a new trend has started.

Do we wait for this resolution? No. Because the range could represent a large part of the ensuing move. In other words we anticipate rather than join the herd on the break to new highs at it did into May’s and July’s top or lower as it did in December fake out. So which way?

The answer lies in Diversion.

At Matrix we seek the greatest volatility combined with the greatest clarity to create our trading strategies. That is not necessarily the market traders focus on or trade most. In other words we divert our analysis to the clearest markets. Indeed if there is as much volatility in these clearer markets we also divert our money there.

SPX is the bellwether of the US stock market and is following one of our capitulation models very closely, Hence why we sold both ramps above 2930. And yet seven other markets show quite clearly what we can expect.

1. VIX.
As a secondary (subordinate) market, one month S&P volatility is a generally hard to analyse consistently over time. And yet it is repeating itself with remarkable similarity with increasing divergence. A lower VIX implies a higher SPX and vice versa.

2. Nasdaq 100
NDX shows scope still to screw traders in a similar fashion (but not scale) to December down to a significant confluence target and partly why we are still running shorts on an incomplete AAPL decline.

3. Russell 2000
RUT has continued to follow our 2019 January projection as a leader of all markets (in terms of time and price but not return) back into its high based on 2014-2015.

4. DAX 
A similarly underperforming market that is following the same period as a previous US capitulation when it fared relatively better than SPX. This outperforming divergence from DAX is one reason why we are closely monitoring how DAX trades compared to the US markets over the next few days.

Although USDJPY is back to being more closely allied to the US 10 year yield, scope for a potential bottom soon for this ‘risk’ currency soon (for a significant albeit corrective upswing) is more help to us than the US Note.

Arguably the clearest market of all,  Nifty is fast approaching our corrective target and one that similarly coincides with 2010 and 2014-2015.

7. Crude Oil
WTI marked out a constructive rally at the beginning of August. Although we sold above 57 with confidence (twice our normal position size) this decline should prove a correction to that rally. Timing a potential bottom soon should not only pay dividends but also, given its lead, help us buy weak indices.

Traders and investors are SCARED going into this long G7 weekend. Bears may be seeing red and appear to be winning the argument for now. But we strongly believe it won’t be that long before this red flag will make the Bull charge.

We have updated our US index view in all time frames as a reflection of our confidence in our so far accurate view but also part of a move to a more frequent and structured update schedule.

Here is a snapshot from our current SPX 3 Month View (key levels are available to subscribers)

We aim to continue profiting from folly or otherwise. We hope you can join us.

Here’s to making the very best.

Good Luck

Ed Matts
Matrix Trade

To receive our weekly articles by email in advance of publication, please sign up for our Sunday newsletter.