Market Analysis

Weekend Charts: Balloon Fairies

Balloon fairyWe’ve shared a lot of information publicly this week to help out and we hope readers have found it beneficial. We don’t like seeing people getting hurt and there is no doubt that people got hurt this week. None of us have a perfect read on these markets, but it’s obvious things have changed and technical damage has been inflicted.

Before I dive into a structural review of the charts some key observations:

  1. All the negative divergences we observed over the course of the past several months indeed meant something and signaled a coming correction.
  2. The consolidation in price was not moving averages catching up to price for indices to prepare for a massive price breakout, rather it was a flat top that produced a fast drop.
  3. Retail got screwed. Last week there were two major moments of lows to buy into this market (after stops were taken out) and it was extremely difficult for retail to participate: a. Many trading platforms shut down during the pivotal moments and b. The subsequent retest occurred overnight during the Japan/China openings and many people woke up to stops having been taken out (again).
  4. Despite a 3,000 point drop in the $DJIA none of the folks pushing the bull case in 2015 have come out and said they were wrong, nor adjusted their price targets. From what I have seen, neither Wall Street bulls nor twitter bulls, warned retail of this coming decline. The notable exceptions: Jeremy Siegel (to his credit: He did come out on CNBC and pointed toward a difficult summer) and our in house bull @Mella_TA who has been pointing out major downside risk for weeks. But in general: Most were making the case for new highs and an imminent break-out. The result: Most people got hurt and much was due to the incredible speed of the decline amidst major complacency. Even very experienced traders got jerked around and for many their psychology was impacted. Yet you hear little of this on twitter. But even twitter bears had mostly a tough time catching this move as the upward “V” action has been relentless for years and forced most to cover on the smallest dips. In fact, many bears covered way too early on the way down and got pummeled on buying the dip. Yes this move has been tricky.
  5. Central Banks still react to price pressure. China practically intervened every day this week and Fed speakers suddenly find themselves acknowledging that sudden market volatility makes the case for a September rate hike much more difficult.
  6. The bull is not dead as we saw one of the largest market recoveries ever recorded, reminiscent of the October 2014 bottom (but different – more below) and tenacious traders were able to take advantage of it.

Now we are confronted with an essential question which will vastly drive investor returns over the next year: Are we in the middle of a cleansing correction which will eventually produce new highs or are we about to embark on a major new structural bear market?

Here’s the reality: Ever since the 2009 market crash there have been no market highs reached or sustained without central bank artificial stimulus. Ever since the financial crisis markets have been supported from one balloon fairy to the next:


Whether real, or perceived, or promised, the ongoing game of easy global central bank money has radically forced cash into equities for lack of alternatives. We have discussed the implications and consequences in detail in the Big Bad Bear Case, so we won’t rehash them here.

Yet the evidence is pretty clear: There is precious little to support the notion that new market highs can be achieved or maintained organically. Yet the FOMC is talking about raising rates while Japan, China, and the ECB remain on a firm path of easy money, consequences be damned.

This conflict represents a major dichotomy and markets are clearly reacting to it. Some may say, pricing it in.

So let’s review the facts:

Major trends have been busted:



Long time readers will recognize a major change: The monthly 5EMA and 8MA have been decisively broken. Now this coming Monday provides a final opportunity at a October 2014 like magic save, but it requires a massive 60+handle rally. It’s not impossible and it would be a jaw dropping event.

But note these MAs are now also intersecting with a major broken trend line that now represent major resistance. One could argue that whenever markets retest these price levels markets must make a major decision, whether to recapture the trend, retest lows, or completely fall apart to new lows.

In context of history several possibilities avail themselves and let me assert 2 in particular as the situation is pretty binary:

  1. If markets are to make new highs bulls need a repeat of 1998.
  2. If markets can’t recapture their trend lines then we may face a much more serious market correction.

The 1998 case has major appeal for several reasons: It represented an aggressive summer correction in the context of a multi-year bull trend and markets went on to produce the 2000 market highs:


Back then the monthly MACD cross was a fake out, as was the trend line break, with the real decline not coming until 2 years later. We can observe that markets are in a somewhat similar situation now.

In 1998 the low did not come easy and followed a period of several weeks of volatility which produced a temporary new low. Going into September and October this year one can certainly envision a similar set-up.

Also supporting the 1998 case: Key monthly MAs have been hit across the board. According to these charts one could argue we hit major historical pivots:




As you can see above historically several of these MA hits produced longer term bottoms. These charts argue strongly in favor of any weakness here being a buying opportunity.

However as the scenarios in 2000 and 2008 outline there is also a possibility that any major bounce into key MAs and/or trend lines also represents a major selling opportunity if highs are indeed in.

The problem for bulls is the following: This recent decline was unlike many of the previous monthly MA hits in the past.

First note that the value line geometric index was simply hammered and is looking at a major generational failed break-out:


Anyway you cut it or slice it this chart does not look like it will easily repair itself. In 1998 we saw a major bounce which produced a lower high while price made new highs. This divergence resulted in the 2000 crash. In 2007 it never recovered until the 2009 lows. So clearly this chart is critical.

The other issue is the $VIX. The monthly chart is showing a repeat wedge breakout pattern with a MACD cross:


The message: The time of low volatility is again over and for now $VIX is back to a historically normal range, but no doubt last week was a historic spike and I know of no historic spike that easily resolved itself to complete calm within a few weeks.

So what’s the risk/reward here?

The risk to the downside is actually rather clear. If the top is indeed in then markets have an eventual appointment with the 38.2% Fib retracing the 2009 rally:


Note this fib corresponds with the breakout level from the 2000 and 2007 highs. It’s an enormous point of confluence.

How important are fibs? They can be huge.

Example: Look where the $SPX stopped this year:


And take the recent massive correction in the DAX, look where it  stopped and bounced from:


And the very same fibs also tell us solid bounce action is also to be had in the weeks to come:


What can produce such bounces? Plenty of possibilities. Don’t forget the balloon fairies are still very much active. One could even argue that a rate hike by the Fed would produce certainty. Markets abhor uncertainty after all and the recent dog and pony show by Fed speakers has produced plenty of uncertainty. Markets also abhor technical disconnects and have a propensity to fill gaps and reconnect with key MAs.

These reconnects will occur. Whether after a retest, or new lows, a V or a W, eventually these markets want to tag their MAs:


What happens then will determine whether we are replaying 1998 or are seeing a major correction or bear market unfold. Who knows, maybe the balloon fairies even have another surprise in store. Some Fed members at least seem to be in favor of it:

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Friday he does not believe the central bank should raise interest rates this year, and policymakers may have to consider further quantitative easing.

Either way, investors better buckle in. Things have changed and traders must adapt.


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