Speculator Optimism Triggers Market Meltdown
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, January 17th, 2008.
Short sellers are having some fun these days, but by week's end don't be surprised to see a surprise rate cut by the Fed. Why not - they've botched everything else up so far, making our short selling activities both easy and very profitable. And a surprise rate cut will not change anything. All that need be done is to prepare. In this regard, with short sellers and put buyers continuing to keep ratios low in unison, even if the Fed does cut rates this week the bounce shouldn't be much, which I will cover technically below. Most that read my work still can't believe put / call and short ratios have that much influence on market direction. And of course it's that disbelief that makes this an easy game, where if it were the other way around it would no be so much fun. In this regard if there is one thing you should remember - remember this - in a mature fiat based speculative environment like the stock market is today, sentiment expressed through betting practices is key in determining market direction. What's more, this is why opinion based sentiment surveys have lost their predictive capabilities.
And this is why North American stock markets have been under pressure of late. The dip buyers yesterday are providing the psychological condition for this to occur. Speculators continue to look for a bounce, so they have been betting bullish. Throw in a little bad news as a trigger, and presto, even though short-term market conditions are oversold (which is the belief system dip buyers are operating under) prices go down anyway. You see they have been conditioned throughout the years to ignore bad news because of the perpetual short squeeze price managers had engineered. (i.e. print lot of money set against a backdrop of increasingly bad news that keeps 'rational speculators' bearish, which fosters a perpetual short squeeze.) But now that bearish speculators are exhausted (broke), this mechanism is broken, where short of all out hyperinflation, attempts to rod the system will continue to fail until a new population of bearish speculators replenishes the ranks. Of course that may not be so easy this time around if an honest to goodness depression develops, with all speculators broke eventually, and set to stay that way. This is why world wars are the only way to get the economy rolling again after a global mania is allowed to run full course.
This is why stocks should bounce on a lasting basis in March coincident with a Martin Armstrong Pi Cycle low - because investor betting practices will change. And if I had to pick a reason for this happening, it would have to be investors will be increasingly hedging / betting on a negative outcome into the seasonal weakness summer / fall months normally bring. So, in this regard, we should expect to experience a seasonal inversion this year due to altered speculative betting practices. Until then however, crazed dip buyers should keep prices falling on a lasting basis into March options expiry if a speculator derived seasonal inversion is to take place. And as mentioned above, it's this mechanism that will ensure any attempt by the Fed to prop up the stock market with a surprise rate cut later this week should prove impotent and fleeting if this I what actually occurs. In this regard I would cover some of your short positions today all things considered (see below) in the belief the Fed will act when the market is closed over the weekend to spark a short squeeze and prevent a Monday morning meltdown.
As mentioned however, the effect of such a move on the Fed's part should be muted and fleeting as long as speculator betting practices remain constant, where if I were to guess at an outcome, the bounce off lows in stocks witnessed here might sponsor a move back up to daily swing lines on both the S&P 500 (SPX) and Dow at 1450 and 13,000 respectively at best. This scenario was laid out technically some time ago, which is attached here. Of course if structural formations are defining the move this time, where in the past speculators normally negate such patterns via increased out buying as denoted on Figure 1 below, then a bounce to produce symmetry in the larger head and shoulders top that is potentially tracing out would see the retrace stopped in the 1425 area on the SPX to test the diamond break. What's more, it should also be noted if speculators decide to start buying puts in earnest again, driving put / call ratios higher on a sustained basis, then the lows seen here will complete a corrective zigzag, with new highs implied, but at this point such an outcome should be considered least likely. The key to knowing what to expect is to watch open interest put / call ratios on the major US stock indices, which is exactly what we are doing. (See Figure 1)
Of course we are also watching other charts and key variables in gaining perspective, with the 'big message' contained in Figure 2 a large part of the reason one should be willing to keep an open mind to a negative resolution to apparent technical structures in the indexes actually tracing out this time around as well. Here, the 'best fit' Supercycle Degree time profile is suggestive a top is indeed behind us, along with a well fitting Fibonacci signature, so we must be respect this condition set until proven otherwise. All we need to see now is indictor / significant stochastic / structural breaks to confirm the ultra-bearish scenario. (See Figure 2)
Certainly one variable (factor) that must be respected right now is the possibility a five-wave rally originating in July might be counted out in the Yen at the moment, and that a correction is immanent. Of course it should be noted this is ultimately bullish in the long-term with five waves higher suggestive of further gains after a correction. What is undoubtedly not being considered seriously by most at present, and as you can see below in the alternate count is the possibility further short-term gains still exists as well. With a strong Fibonacci resonance signature defining resistance here however, discretion might be the better part of valor in terms of 'hoping for more', meaning a retrace is most likely at this point, which will bring the carry trade / inflationist types out of the wood work again for a period of time. Naturally a correction in the equity complex higher from here is no surprise to us based on the above, with the coincidence of a negative (carry trade / liquidity positive) short-term outlook on the Yen strengthening the belief this should be expected at this point considerably. (See Figure 3)
And its Martin Luther King Day on Monday, where holidays have the propensity to spark rallies, so again we have yet another reason to look for higher prices. Add to this options expiry tomorrow could spark such a rally anytime with the draw of high put / call ratios at far higher strike prices, and we have a recipe for a short-term rally that cannot be ignored. As with the long-term picture of the SPX displayed above however, as you can see below the 'big picture' for the Yen is far more bullish than bearish from a technical perspective, which in turn supports the case for a larger degree top in the global credit cycle / equity markets as well. This chart is suggestive that after a test of the indicated breakout, an end to the Yen Carry Trade might become evident to all with a decided break higher in the Japanese currency. (See Figure 4)
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