BullBear Trading: Stock and Financial Market Technical Analysis

05/01/11 BullBear Market Report

by Steven Vincent

BullBear Trading

 

INTRODUCTION

 

In the last BullBear Market Report, I called for a minor near term correction to support that would be a buying opportunity, and we got just that.  The market continued to show decidedly bullish tape action, as selling sparked by ostensibly bearish news items--most notably the S&P warning regarding the US debt outlook--resulted in buying opportunities.  Here's a chart of the scenario as I saw it on 04/05/11:

Indeed, the yellow support zone held and minor wave ii bottomed out just about on target.  After a bit of minor volatility, I'm fully long again from SPX 1313.

In the last report I also noted that many major indices and sectors were trading either at or very close to all time highs or the 2007 highs.  On the last trading day of April, Nasdaq Composite closed above its 2007 high while S&P 500 Equal Weighted Index, Russell 2000 and Dow Transports all made new all time daily, weekly and monthly closing highs. It's particularly significant that SPX-EW has beaten the capitalization weighted index to a new high by such a wide margin, since this indicates that the underlying breadth of the bull market is quite strong.  Other key market sectors to close at new all time highs include: Consumer Index, Cyclicals Index, Defense Index, Healthcare iShares.

It's also significant that these major technical events have garnered virtually no recognition.  A Google search for news turns up almost nothing and the major financial media web sites do not mention it at all.  From a contrarian perspective, this is evidence that, incredibly, the predominant view remains bearish.  In fact, a perusal of the popular financial blogging sites shows a continued predominance of bearish views and expectations in the face of consistent market strength.  The bearish hangover from the 2007-2009 downside party is so severe that it has yet to wear off.  This may be the most unbelieved bull market in history.

While there is some evidence that professionals are heavily bullish and probably fully invested, an examination of the data reveals that this is not necessarily bearish from a contrarian perspective.  It would only be long term bearish if such bullishness were matched by a similar commitment from the retail investor.  There is overwhelming evidence that the retail investor and small trader remains either out of the market or bearish, waiting for the next "collapse".

Here's a good way to evaluate the psychology of the market.  Ask this question:  When the average trader or investor looks at a market, is he looking for an excuse to sell and/or stay in cash or is he looking for a reason to buy?  Then ask the same question of yourself.  If you answered truthfully, chances are very good you just discovered that the majority--even those who profess to be bullish--are still oriented towards fear and safety when they evaluate the market.  Those who actively plan for and assertively execute a program of seeking out buying opportunities are few.  Yes, that is in the process of changing now.  We may now be at the beginning of the phase in which that sidelined money starts to chase the market higher and higher.  At the next significant top, we should be hearing chatter to the effect that "the retail investor has returned to the market with a vengeance and brokers report a huge increase in daytrading activity".

The next month is likely to be dominated by wall of worry chatter about the US government debt ceiling and "Sell in May" rhetoric.  Fortunately for the bulls, there is never an end to worrisome items that keep investors and traders either on the sidelines or on the wrong side of the markets.

In the body of this report, I'll be analyzing SPX, Nikkei, Emerging Markets, Gold, Silver, US Dollar and Commodities.  But first, I'd like to answer some reader questions.  I received this email from a BullBear Traders member:

I am really enjoying following your BullBear Trading service, and the BullBear Tweet service too.   I am positioned aggressively long right now, essentially following your sense for an impulsive "melt-up".  I am new to swing investing and am busy climbing the learning curve.

Two questions/comments.  I've somewhat lost track of the fundamental thesis you are maintaining for this current expected rise.    I had understood it to be a shift from bonds into equities, presumably due to rising rates. Your latest on this said:  "The secular shift from the perceived safety of bonds to riskier assets should soon evolve to the next level as the short end of the Treasury market starts to unwind.  The 2 Year Note looks ready to break out, unlocking a huge cache of capital from ultra low yields in search of higher returns.  This will be a major boost to the bull market and and underlying driver for the next run up." Is this still the mechanism that you feel is underlying this current wave iii? I don't have the sense that rates are rising differentially at the moment, yet the expected wave is unfolding anyway.

Could it be the falling dollar is causing this same sort of rush into stocks that rates rising off the bottom would? And how about a more fundamental fundamental, for this earnings reporting season, that the worldwide middle class rise, coupled with the now meaningful international exposure of large-ish US caps, is recasting the US stock market as emerging growth in a time of, well, emerging growth?

Secondly, I've cast around the net for someone who might dovetail on a day-trading basis with your slightly longer swing perspective.  I am looking for something that can help me possibly trade the intraday 3 and 5 wave counts which seem to be internal to those you identify as part of your longer term outlook.

Many thanks for your continued guidance.

Peter D. Ward

 

Thanks for your comments Peter.  You raise a number of important points that I'd like to answer for all my members and readers.

With regards to a "melt up", I don't believe I have been calling for precisely that.  The silver market is what I would call a melt up.  Having said that, some of my preliminary research is leading me to conclude that in fact the current wave off the March bottom should perform very much like the momentum move off the September bottom.  My sense is that it should carry all the way back to or near the all time highs before any significant correction.  It should continue to surprise most market participants. Naturally, as a BullBear, I will always keep the other side of the market on my radar screen.  But at this time I see no reason to expect anything other than a continued rally.

With regards to my "fundamental thesis", in the traditional sense, I have none.  I have no idea what is going to happen with regards to the economy, earnings, inflation, deflation, global warming, Middle East tensions, Peak Oil, Warren Buffett's successor or Barak Obama's birth certificate.  I don't know what the consequences of a higher or lower US debt ceiling would be.  Nor do I care to know.  In fact, I find that the less I pay attention to any of these so-called fundamentals, the better my trading gets.  Traditional fundamental analysis leaves the trader/investor in the vulnerable position of having to rely upon predictions that are almost always wrong enough to cause losses.  I used to read, watch and listen to EVERYTHING I could find.  Now I only read, watch and listen to just enough to get a picture of the sentiment environment.  I used to know when each and every important earnings report would be issued.  I couldn't tell you who announced this last week or who will be announcing on Monday.  Ignorance is bliss.  My trading has only improved as a result.  Ultimately I don't care at all why the market is going up, only that I am on the right side of it.  Some day we will be able to look back and identify the reason for the bull market we are in right now.

So if I'm not paying attention to all these factors that are generally regarded as crucial fundamentals, then what am I paying attention to?  The message of the market as written by its price action.  While its easy to believe that we can know what is going to happen to some so-called "fundamental" factor, most often we're wrong or our timing is egregiously flawed or our interpretation of the significance of the factor is mistaken.  When we clutter our heads with fundamental beliefs ("the market MUST crash because fundamental x is simply unsustainable") we position ourselves to do nothing, the wrong thing or become complacent because we rely upon that belief structure.  The truth is we can't really know what the future will bring.

We can, however, know what is happening in the market now (and in the past) and by understanding deeply and correctly the nature of current action we can anticipate the quality of future action and position ourselves accordingly.  The present is the point of power and the only time frame in which we can really take effective action.   In my view, price action is the ONLY fundamental.  What is price action?  The dynamic between the supply of stock on the market and the demand for stock in the market.  Naturally there are a number of factors which shape both the supply side and demand side of the equation.  But we are basically talking about LIQUIDITY as the only real fundamental with which the trader needs to be concerned.  Is there more demand than supply?  More supply than demand?  On what time frame?  How long will the imbalance last?  When will it equalize and shift back again?  Anything that gets in the way of this true, fundamental, core understanding needs to be set aside and banished from the trader's mind and frame of view.

When I discuss the flow of liquidity from bonds to stocks, THAT is the fundamental that I am addressing.  You mention "I had understood it to be a shift from bonds into equities, presumably due to rising rates".  In fact I see rates rising because of the move from bonds to stocks.  It's a subtle but crucial distinction.  Bond yields are rising BECAUSE investors are shifting capital to riskier assets in search of a higher return (presumably because higher inflation is eating into their already low bond yields). This is bolstering the demand side of the equation for stocks.  I expect that dynamic to eventually move into the short term Treasury market as well.  

But we are already starting to tread dangerously into "fundamentalist" territory here.  If we're not careful, we'll erect a predictive model that is tied to a desired outcome--a dangerous psychological construct.  As you note, we have yet to see the short term Treasury market crack and yet still the market is still rising.  There is rarely a one-to-one intermarket liquidity correlation.  The observation that the unwinding of the long bond has bolstered demand for stocks appears to be valid, but we shouldn't become attached to the notion that this phenomenon must continue or widen into other areas of the bond markets.  I'm merely observing here that this could happen and that the markets BY THEIR PRICE ACTION have been suggesting that it could happen.  While this kind of intermarket liquidity analysis can be very useful in evaluating the fundamental supply/demand dynamic in the markets, we need to be careful that we don't turn it into an exercise in fundamentalist prediction.  Let's say I end up being completely wrong about the Yen, the Dollar and Bonds.  Just to reiterate: As long as I am on the right side of the market, I DON'T CARE!  Trading is not an intellectual exercise to prove that you are smarter than the market or better at prediction than the next guy.  The only thing that matters is keeping on the right side of the market!

Could it be the falling dollar is causing this same sort of rush into stocks that rates rising off the bottom would?  Basically, yes. And the same thing applies to the renewed Yen carry trade.  These are all liquidity factors that affect the supply/demand balance.

You also ask "the worldwide middle class rise, coupled with the now meaningful international exposure of large-ish US caps, is recasting the US stock market as emerging growth in a time of, well, emerging growth?".  Again, we tread dangerously here into fundamentalist territory.  We can answer this question, or attempt to, as long as we understand that it is for purely entertainment value ONLY.  It's crucial that we keep in mind that we will not know why the market is doing what it is doing until much later and that essentially the reason DOES NOT MATTER.  So for purely entertainment purposes, as mere idle intellectual gamesmanship, as simple diversion for the mind, I would say that one distinct interpretation of the market's action off the March 2009 low, its current action and my current sense of future price action is that two thirds of the planet is in the early stages of a historic growth phase that will last another 25-30 years and that the developed world will continue to see radical advances in technology across every sphere of human endeavor and that these two factors may underpin an ongoing bull market potentially on the order of the move seen from 1982-2000.  This is NOT a prediction.  This is NOT a forecast.  This is one possible interpretation among many that could explain, in whole or in part, the market price action that we are seeing today.  And again, we won't know until it's already happened and, right or wrong, THE REASON DOES NOT MATTER!

"I've cast around the net for someone who might dovetail on a day-trading basis with your slightly longer swing perspective."  My response is the same that I would give if confronted by a friend holding a loaded pistol to his head and contemplating pulling the trigger: Don't do it!  There's so much to live for!

Day Trading is trading suicide.  Period.  I don't care what the industry propaganda tells you.  It is not possible to intelligently trade the random noise of day to day market activity.  Simply put, the larger the time scale, the easier and more reliably it can be traded.  The intermediate scale is the smallest scale that should be attempted.  Anything under that is just random noise.  This last month I really pushed the edges of this by trading the minor ii pullback.  Remember how difficult that was?  In the end I was able to pull it off, but not after a couple of stop losses.  Elliott Wave counts on anything less than a 4 hour bar chart are worse than useless.  The wave dynamic does not, in most markets under most circumstances, work on a smaller time scale.  In spite of what you may have been told, it is NOT perfectly fractal on all time scales.  Other technical methods also break down as the time scale shrinks.  Recall the words of Jesse Livermore:

 “There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.  No man can always have adequate reasons for buying or selling stocks daily – or sufficient knowledge to make his play an intelligent play.  I proved it.”

I proved it too and there's no need for you to prove it all over again.  If you don't believe me, believe Jesse.

 

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