Well they did it again. The entire summer was a giant pump and dump game. Get retail money inflows to sell supply. The peak? The big whale, the $BABA IPO of course. And so the airwaves, main media, twitter and online news sources were filled with bullish stories and the raising of price targets. Voices of caution? Few to none, or on rare occasion some brought out to be mocked. The now famous September 16 CNBC interview with Bill Fleckenstein was the proverbial top signal of financial media arrogance. The lesson: Don’t look to Wall Street for a tradable sell signal.

But fortunately we now live in an age where dissenting voices and analysis can be found outside the main stream and a track record of timelines can be kept and shared. I’ve taken the liberty to contrast the Wall Street headlines in the weeks leading up to the September 19 market top with some of our own analysis which warned of weakening signals and even made a case for an 11% correction one trading day after the market top:

None of these people warned retail investors that the rally was weakening, that they could get hurt and that a correction was likely imminent. Remember that all the price target raises came in an environment of record margin debt. High margin debt of course exacerbates risk and can result in cascading selling and this is clearly what happened this week. But don’t worry they said, there’s cash on the sidelines. Ugh. Now this week actual panic was in the air as oil and stocks got crushed with a panic move into bonds. The severity of this price action and panic is evidenced in this weekly $TLT chart:

It’s frankly been a frustrating summer to see the fakery of much of the price action, the extreme complacency, the increasing bullishness in tone and to be a lone voice urging caution. To be out in public with a contrarian view is never easy when the crowd is squarely heading in a different direction. But I do take pride in the quality of our analysis and I want to highlight one chart and market call in particular as it is superbly relevant for what is likely to happen next, so bear with me for a moment:

Of all the articles on this blog I want to draw your attention to “The Wilshire Connection” from September 5. In it I showed the following chart:

In that article I called for a corrective move toward the middle Bollinger band and also declared it a buy zone:

Its main signals:

1. The RSI is turning south and from a weaker level than at the previous high

2. The RSI is turning south while the $WSLH is still very far disconnected from its monthly 5EMA/8MA. Why is this important?

3. Because it relates to the monthly MACD. The coming reconnect of the MAs will not only drive the RSI lower it will create a very high probability scenario that after 4 years the monthly MACD will finally cross-over.

This would be seismic shift for this market and bring about the elusive corrective scenario. The principle target would be the middle Bollinger band which we haven’t tested since November 2012, the launch of QE3. Note: Would love to trade long there for a nice bounce.

But Alibaba and $AAPL first next week and then off to OPEX. Lots to happen and lots of magic ramps between now and then I’m sure. But don’t forget about the Wilshire Connection 😉

Here is the same chart now:

I am singling out this chart because I see it as a critical milestone for this bull market. The RSI and MACD are screaming loud warning signs and should have everyone concerned. In fact, they are repeating such rare patterns that a larger correction is most likely on the horizon. But maybe not yet. This week I made the case that we could actually see new highs first based on a repeat of the 2007 analog.

A close look at the chart above makes it very clear that these middle monthly Bollinger band tests off of new highs are rather common and are followed by new highs. We saw this in 1996, 1999, 2000, 2005, 2006, and 2007. In this context a move to new highs is certainly with historical precedent. Yet a close watch ought to be kept on the MACD. Were we to close the month with a cross it wouldn’t bode well for November, positive seasonality or not. So the case is far from clear cut.

But the month is far from over and markets are still vastly oversold despite the massive bounce we saw off the double bottom this week. Next week is shaky seasonally speaking, but it is also the heaviest final POMO week of the month. Also recent larger pullbacks have made clear that shocks to the system tend to require consolidation first before moving higher and this week clearly qualifies as a bit of a shock.

Let’s also be clear that significant technical damage had been to charts which is self evident in the following examples:

The $DJIA chart above also shows how violent the move this has been as evidenced by the deep pierce below the lower Bollinger band. These type of charts don’t just bounce back to new highs. This will take some time to repair.

Yet the oversold signals are pronounced and we are finding ourselves at an interesting period of the year. Clearly the Fed got spooked this week and felt necessary to jawbone the market. And not only the FOMC, but the ECB clearly also felt it necessary to remind people of the baton effect by announcing that asset purchases were imminent. They are skittish aren’t they? To me this is still the biggest red flag out there: Central bankers getting nervous and feeling the need to calm markets the second they show volatility. Why so scared folks?

The main message: They are watching markets closely and the Fed is meeting again before the end of the month.

Oversold signals abound. Examples:

One of the most important signals this week was the astonishing relative strength in the small caps. In fact, the $IWM seemed to completely veer off the 2011 script:

The large recovery bounce this week may also bring the $NASI close to a buy signal:

If one wants a really bullish outlook the recent price action actually seems to have built a rather sizable inverse structure:

Bottom line, we may have simply seen a much needed washout for a market to rid itself of the excesses of the past couple of years. Q4 performance chase may be upon us and scared central bankers may just give them the excuse to rally this bad boy back up to new highs. As I remarked on twitter:

People waited for years for a 10% correction, but then didn’t pull the trigger when it happened. Trading Psychology: http://t.co/V7PFNxexmm

— Northy (@NorthmanTrader) October 17, 2014

Now before I start sounding like a raging perma bull, I’m not. The $WLSH chart above is bearish as heck. To me the next few weeks or months are about a tradable bounce. Ebola fears aside (and they could derail any bounce here) we still have a world economy with shrinking growth and hapless central bankers throwing money at it with little success to show for it. The structural problems are real and the 23.4% poverty rate in California for example is a national shame and disgrace. While Janet Yellen is lamenting wealth inequality she is not taking any responsibility whatsoever as her and Ben Bernanke’s policies have contributed significantly to the largest wealth transfer in modern history. And so the macro bearish case remains. So for now it’s a matter of how high of a bounce before the larger corrective move:

What would change my mind? Show me actual growth, not growth based on buyback gimmicks at the expense of CAPEX, show me wage growth that doesn’t further impoverish people, show me a structural move that reverses the long term trends of shrinking labor participation, expanding wealth and wage inequality and show me creation of well paying jobs as opposed to crappy temp jobs with little benefits and zero upward mobility. Show me an economy that starts showing benefits for the many and not only the few. And show me confident central bankers that can keep their fingers off the artificial liquidity button.

None of these things are on the horizon, not even close. So we need to wait for some structural improvement. In the meantime we trade long and short based on how we read the tape.

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