Trader’s Narrative

With the second year anniversary of the 2007 market top coming up in a few weeks, here is a video which points out that the S&P 500 index’s date with destiny is also marked by two major technical forces:

The reason for a correction are piling up. We’ve already talked about sentiment and Lowry’s expectation of a correction. This is yet another reason to rein in any bullishness (at least in the short term).

While this rally has gone on longer than even the most optimistic bull predicted, don’t forget, we are still mired in a secular bear market. As the video mentions, we have yet to put in a higher low to denote that we have a change of trend.

On October 9th, as the market dropped into the abyss and then stepped back to form a wide ranging doji candlestick, I quipped that if this wasn’t a bottom, to go find a cave and buy a gun.

After a brief sojourn below the low of that day, the market recovered and is now trying to claw its way back for good. Many are noticing that the S&P 500 has now broken above its downtrend line (two):

But as you can see in the chart, this isn’t really the first time it has done that during this downturn. In late October, it decisively broke above the downtrend line (one) with a very wide range up day.

Then it gave it all back and more, falling well below its previous swing low. My hunch is that the third time will be the charm (light green three).

If we invert the chart and imagine it has been uptrending, it is easy to notice the familiar pattern of 3 line breaks.

Today Bernanke’s testimony on Capitol Hill stoked a rally as the market interpreted him to be more dovish than previously. Specifically, he said:

We must take account of the possible future effects of previous policy actions — that is, of policy effects still in the pipeline.

This was taken to mean that Bernanke is not in a hurry to push rates to extremes in an effort to control inflation but instead is willing to take a more relaxed approach to allow the effects of previous increases work themselves through the economy.

The market may think this is bullish, but according to James Stack of InvesTech, history shows evidence to the contrary:

…in the past 80 years, there has been over a 71 percent probability that stock prices will be lower six months after the final rate hike.

In any case, the market had a fantastic trending up day. In fact, it was so bullish that again, we saw more than 10 times the volume in stocks closing up than down. I wouldn’t be surprised if it was also one of those fabled Lowry’s 90-90 days too. This sort of market action is very rare because such skewed positive days don’t usually cluster this close together (we had two other ones in the past month). But eventhough they are rare, they are unmistakably bullish.

The volatility, as measure by the VIX index, got crushed again today falling intraday almost 18% ! To be honest, I’m getting tired of this. Uncharacteristically, it has been happening a lot lately. Historically it has been bullish but the reason I don’t really like it right here is because it shows a market that is too ready to abandon its skepticism. And as you know, skepticism, like virginity, should not be abandoned too readily.

We see this same phenomena in the Hulbert Stock Newsletter Sentiment Index (HSNSI). According to Hulbert, at the end of June, when the S&P 500 was at 1270, the HSNSI stood at 12.6%. Then days later on July 12th when the S&P 500 was lower at 1258, the sentiment reading was higher at 31.4%. And the Hulbert NASDAQ Newsletter Sentiment Index went from a -25% at the end of June to 0% on July 12th, eventhough the Nasdaq fell more than 40 points. Tsk, tsk. That’s not what lasting rallies are built on.

Here’s the daily Nasdaq 100 chart :

According to the classic definition: lower lows and lower highs; we are still in a clear downtrend. We’ve just put in our third lower low in fact. And unless the previous high is taken out and a higher high put in, we can’t really claim that the trend has changed. For that to happen, we would have to see the index climb all the way to close above 1600.

Is it possible? Sure. But if the market does go up from here, you can bet that it won’t be powered by the old has beens of yesteryear: Yahoo!, eBay, Microsoft, Dell, etc.

Instead, look for tomorrows leaders to be unknown, mid-caps, in unpopular sectors and possessing the ever important, strong relative strength.