10.28.2011
Our call for a likely multi-week rally three weeks ago has turned out to be accurate. Equity markets worldwide have experienced anomalously large gains since the October 4th lows, with many indices up more than 15%. As strong as this intermediate term rally has been, long-term downtrends in the major US equity indices have not been broken. The NASDAQ and S&P500 both tested long-term downtrends this week – sustained moves higher in the weeks ahead are necessary to confirm new long-term uptrends.
If the market does not revert back below the lows of October 27th in the next week or so, then the probability is high that a new long-term uptrend has emerged. However, signs have appeared that indicate the uptrend off the October lows is aging – former leaders have fallen hard, former lagging stocks and sectors are attracting money at the expense of former leading sectors, and aggressive sellers have made their presence known.
The rate of advance since the October lows is unsustainable and has characteristics of a bear market rally. Structural shorts, or, those who believe the market has entered into a long-term downtrend, have likely begun to reinitiate positions this week, as rallies have been spiky and have drawn in aggressive sellers at levels of resistance. This group of sellers will remain active henceforth. The deciding factor in the long term trend of the market will be the aggressiveness of the buyers: will they continue to overpower the sellers as they have since the October lows? Or have they put all the money they wish back into the market already?
We see the following scenarios as most likely in the weeks ahead:
1. Continued consolidation around current levels with false upside breakouts, then resumption of the long term downtrend; possible test and breach of October lows several weeks thereafter
2. Consolidation then breakout above this week’s highs to confirm new long term uptrend; possible new highs for the year within weeks to a month or two thereafter
While these two scenarios are polar opposites, it is clear that price stability has not yet been established, which lends a greater weighting to Scenario 1. Additionally, the long-term downtrends of the major European equity indices, the Dow Jones World Stock Index and the Emerging Markets Index have not even been tested. While the gains in the month of October have been impressive, the long-term downtrends set in motion in early May of this year have yet to be fully extinguished. There will be a battle in the weeks ahead between buyers and sellers, and plenty of articulate arguments for both the bearish and bullish side. What is important is whether the markets are able to sustain around the highs of this week. This is a binary outcome situation, which is why the moves of the past few days have been emotionally driven and quite large. If the VIX volatility index, which has come off significantly in recent weeks, continues to decline and realized volatility does the same, then the market will likely continue to rally for months. Otherwise, a resumption of long-term downtrends has a high probability of coming soon.
Friday, October 28, 2011
Wednesday, October 5, 2011
Resolution
10.5.2011
The eight-week trading range from early-August to late-September was finally breached the first two days of October. The move came to the downside, which was the most likely scenario. Our call for a very brief dip below the August 9th lows turned out to be correct. Last week we outlined a likely breach lasting several hours to no more than a few days – as it happened, the S&P500 remained below the August 9th low for a total of seven trading hours before a tremendous late-day rally on October 4th brought the index back above the August 9th low.
As the market has behaved just as expected, given the influences of current long-term and intermediate-term downtrends, clarity on the likely path of the market for the coming weeks and months has increased. There are four likely scenarios from here:
1. Market reverses down immediately, breaches the October 4th low, continues lower for a couple of days more, then rallies for several weeks to a month or two
2. Market rallies for several more days, perhaps a week or so, then retests the October 4th low
3. Market consolidates sideways for a few days, nears or retests the October 4th low, then rallies for several weeks to a month or two
4. Market continues to rally strongly off the October 4th low for several weeks to a month or two
We see Scenario 2 or 4 as most likely, Scenario 3 slightly less likely, and Scenario 1 as the outlier.
As the long-term downtrend that began on May 2nd remains intact, all rallies are likely to fail at some point. The key will be to determine when and where the failures are likely to occur. As the market continues to digest ongoing news flow regarding the economy, corporate earnings, and sovereign debt in the months ahead, the likelihood of a ‘surprising’ rally lasting several weeks to a month or two is now high. However, the rally is unlikely to breach the 2011 highs before failing and perhaps testing the October 4th low.
Markets tend to move relatively smoothly in long-term uptrends and choppily in long-term downtrends. This is due to the fact that downtrends trigger heightened emotional responses, which lead to markets overreacting to the downside, which leads to violent swings back upward. The very long-term tendency for money to generally flow into the equity market is another factor that creates choppiness during downtrends, as underlying long-term buyers do battle with cyclical sellers. We have seen this battle play out the past two months, and it will be ongoing for the foreseeable future.
In summary, there is a high likelihood that a multi-week rally has begun or will begin sometime in October. If the advance continues in a vertical fashion the next few days, there is a greater likelihood that the market will retest the October 4th low before any multi-week rally can occur. However, once the market does pivot into an intermediate-term uptrend, the rally may extend for a month or more thereafter.
The eight-week trading range from early-August to late-September was finally breached the first two days of October. The move came to the downside, which was the most likely scenario. Our call for a very brief dip below the August 9th lows turned out to be correct. Last week we outlined a likely breach lasting several hours to no more than a few days – as it happened, the S&P500 remained below the August 9th low for a total of seven trading hours before a tremendous late-day rally on October 4th brought the index back above the August 9th low.
As the market has behaved just as expected, given the influences of current long-term and intermediate-term downtrends, clarity on the likely path of the market for the coming weeks and months has increased. There are four likely scenarios from here:
1. Market reverses down immediately, breaches the October 4th low, continues lower for a couple of days more, then rallies for several weeks to a month or two
2. Market rallies for several more days, perhaps a week or so, then retests the October 4th low
3. Market consolidates sideways for a few days, nears or retests the October 4th low, then rallies for several weeks to a month or two
4. Market continues to rally strongly off the October 4th low for several weeks to a month or two
We see Scenario 2 or 4 as most likely, Scenario 3 slightly less likely, and Scenario 1 as the outlier.
As the long-term downtrend that began on May 2nd remains intact, all rallies are likely to fail at some point. The key will be to determine when and where the failures are likely to occur. As the market continues to digest ongoing news flow regarding the economy, corporate earnings, and sovereign debt in the months ahead, the likelihood of a ‘surprising’ rally lasting several weeks to a month or two is now high. However, the rally is unlikely to breach the 2011 highs before failing and perhaps testing the October 4th low.
Markets tend to move relatively smoothly in long-term uptrends and choppily in long-term downtrends. This is due to the fact that downtrends trigger heightened emotional responses, which lead to markets overreacting to the downside, which leads to violent swings back upward. The very long-term tendency for money to generally flow into the equity market is another factor that creates choppiness during downtrends, as underlying long-term buyers do battle with cyclical sellers. We have seen this battle play out the past two months, and it will be ongoing for the foreseeable future.
In summary, there is a high likelihood that a multi-week rally has begun or will begin sometime in October. If the advance continues in a vertical fashion the next few days, there is a greater likelihood that the market will retest the October 4th low before any multi-week rally can occur. However, once the market does pivot into an intermediate-term uptrend, the rally may extend for a month or more thereafter.
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