Excerpted from the September 19th edition of Notes From the Rabbit Hole

Here is an excerpt from NFTRH51, discussing the broad stock market from a risk/reward standpoint. Beyond this excerpt, #51 went on to discuss sentiment readings, money supply, commodity leadership, the US Dollar, long term treasury bonds and of course, in its most extensive segment, the precious metals.

Finally, portfolio structure was reviewed with the speculative portfolio now up 70% from one year ago (NFTRH baseline) and +169% off of the bottom in Q4, 2008. This is stated not to boast, but rather to illustrate the benefits of being contrary the herd. Now, slowly but surely, the herd is becoming ever more bullish.

Stock Market

The SPX has finally come to our 'big picture' bull trigger point, above the monthly EMA 20. Success at this level means we will no longer be able to deny the bull market's viability as something more than an intense reaction to nearly equal and opposite downside from the hard down phase of last year.

The problem is that it has merely come to the bull point, not confirmed it. I do not have detailed data from the 1929-1930 chart that has been shown on the blog, but I am sure that upside reaction (approximately 50% retrace before ultimate and sustained heartbreak) had triggered the MACD and some exciting moving averages as well. But again, looking at the situation without the Great Depression baggage*, we should look to the multi-month struggle at the EMA 20 that occurred in 2003 as a guide to the work that must be done to confirm some extended bullishness.

This would be the hard work that must be done to test the bulls' mettle. Short of this, and in the event that the market simply proceeds to a 50% or higher retrace in the near term, I cannot become bullish or lower the risk profile. That is because hope is a lousy underpinning and it is because the market will not have had the chance to purge the unhealthy holders that are surely now densely populating the long side. We'll look at their progress later as we return to our sentiment readings.

Of course the bearish view is wrong. It was wrong yesterday, last week, last month and since March. That is undeniable and bullish price action is causing a lot of emotion out there. But risk is separate from price action. Risk could express itself on Monday or it could do so later, above the 50% retrace level. We do not control the markets. We simply evaluate them on an ongoing basis and adjust as needed.

The market recovery is still firmly on the game plan NFTRH plotted many months ago as today's brave bulls were nowhere to be found. The process is taking a long time to play out, but isn't that always the way? True to form, things are being pushed to their limits all around and nothing is conclusive as many of the charts to follow today will show.

To summarize, there is a case to be made that assets (except for the US dollar) can propel higher short term. There is also a case to be made that the party will end shortly. Regardless, the risk vs. reward is not good even as prices continue to rise, and we must deal with that. Some leading global markets and the US' own Nasdaq are already dealing with the EMA 20 level in a positive manner. Other key markets like the S&P 500, Dow and Japanese Nikkei have not yet done so. It will be helpful now more than ever to watch leading markets, like the NDX, Hong Kong HSI and China 25 (FXI etf) for clues.

What Do Leadership Technicals Say?

The China 25 fund in ratio to the SPX proxy SPY provides a great view into market leadership, both to the upside and down. There has been a weekly breakdown from a rising wedge along with a MACD trigger down. That is a warning sign that has been in effect for five weeks now, as the candles hug the underside of the wedge. FXI is expected to lead SPY into the next decline, and this chart is not bullish.

* The Great Depression put many of the same pressures on the system that we are witnessing today, and government's response today is very similar. Do you believe that FDR's policies ended the depression or extended it? Government manufactured stimulus can never be a long term solution and can only make matters worse by not only not focusing on productivity, but also by injecting very non-productive and wasteful policy - the same policies that have already proven a failure - into a system that badly needs the opposite to cleanse itself.