Another great week of volatility. Trading the repeating corrective structure the past couple of weeks has worked very well. The push lower this week was met with buying into Friday per the expectation we outlined in Trading the Abyss on Wednesday. One of the main stories still largely ignored by equity markets remains the incredible strength in the dollar which has now risen for 12 weeks straight, supposedly without causing any detrimental impact on earnings. Indeed Thursday’s and Friday’s recovery rally off of the lows was powerful and pushed the $SPX back above its 5EMA and this has been a very bullish sign in the recent past.
In fact, one could easily make a very bullish case here as we are just seemingly replaying the same structure we have seen several times this year. Most predictably the bullish voices made their case on CNBC on Friday:
In this context of this chorus of bullish views it was then a bit rich for Tom Lee to come out and calling his bullish view the contrarian case:
But that’s all part of the game of course. But note one really interesting aspect of Tom Lee’s bullish case: His premise for the year end rally is not based on fundamentals, earnings, revenues, growth or anything. In his words: 1. Hard down day on the first trading day of October tends to produce a big rally 2. Fund managers have to chase performance. That’s it. You can watch it directly by clicking on the image above. He may well be correct of course, but I do take note that the principle justification is a historical one and based on a need to chase price for competitive reasons not for fundamental ones.
Are they all correct? Push higher from here? New highs coming? All is well? Let me walk you through both sides of the argument as I see it. First the bullish case that is based on a repeat of the recent structures, and then a more bearish view that is based on some concerning changes that lie beneath.
First the bullish case:
The daily $SPX shows a basic repeat of previous corrective structures:
The weekly chart shows some weakness, but nothing unusual that we haven’t seen before thrusting higher:
This week I told members to expect a touch of the monthly 8MA with a likely bounce to occur, and surely enough this is what we got:
Now the month is far from over and this rally’s history seems to suggest we can just keep bouncing higher from here. OPEX is in 2 weeks and these have been very bullish as of late. Add bullish Q4 seasonality and the bullish case is in the bag as they say. Let’s add up our year end bonuses already, right?
Not so fast. There are some really interesting things lurking beneath and they are not pretty, in fact some have the potential to be outright frightening. The facts:
The $NDX has broken the lower trend line of an ascending wedge and is potentially repeating an earlier structure that would point to further downside in the days ahead:
Now to the big guns. What, precisely, is bullish about this monthly $RUT chart:
Anyone? It is true the $RUT is very oversold and on that basis we played it long into the lows this week for a nice bounce. And certainly the bounce could continue, but beyond a bounce what is bullish about this chart?
But hey that’s just the $RUT you say, ok then let’s look at the composite picture of the $WLSH, the entire market:
The entire picture is weakening to the point where the market is facing the prospect of a monthly MACD cross-over. The previous 4 occasions of the same sort have produced very sizable corrective activity. In short: Bulls are under severe pressure to avoid a cross-over this month. The relative RSI picture is horrendous and again I have to ask: What’s bullish about the RSI?
The RSI is of course reflecting what’s happening underneath, the internals are horrific. Despite a current seeming repeat of the earlier structure we have to take note of a severe weakening of the high lows. In the summer I pointed out the fact that we were in the midst of experiencing the largest uninterrupted positive run for high lows. The last two larger negatives on that front were driven by the end of Q1 and Q2 respectively. I had mused what would happen when Q3 was about to end. Well the market is making it very clear now isn’t it?
The sharp negative divergence is similar to the 1998 and 2008 precedents and as the chart outlines much further downside could well be ahead on a repeat.
But you won’t hear Tom Lee mention this. Nor did he mention the dollar:
So what’s the truth in all this? I tell you one truth: The reason we haven’t made new highs again yet is because the M1 money supply hasn’t made a new high:
Another truth? The market just retreated from the most bullish asset allocation it has ever seen. One could argue we just witnessed a false break-out this summer:
Yup everybody is still all in. But some folk are getting out whilst the vast majority is still hanging on. Maybe they are telling themselves the market is cheap and not overextended. To which I say: Good luck with that:
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Categories: Market Analysis
Good write-up. I’m very much in the “not seen the bottom yet” camp. I see further downside as nothing more than normalisation as qe3 comes to an end. Usd strength is signaling tightening of financial conditions. Yes they will stay very loose but it’s the direction that matters. Those leaning bullish for any reason other than to chase performance as tom lee recommends should be looking at other markets than the us where you can buy the same things at much better valuations. Final point: as a permabull, tom lee has been right these last few years. But this is certainly not the norm as anyone familiar with his track record knows. So in a sense him being wrong again would also be part of the normalisation trade.