The market is up over 4% in as many days and it looks like the
Fiscal Cliff worries are behind us! Rally Hats on! At
least that is how the media justified the rallies surrounding this
New Years. A few of the many enthusiastic headlines are
below:
" Wall Street ends 2012 riding high on "cliff" deal optimism -
Reuters
"Stocks rally on hopes Congress might act" - CNN Money
"Global Stocks Rally Over U.S. Cliff Deal" - Wall Street
Journal
This sounds all good and dandy, but optimism and hope are not
appropriate investment strategies. Are global markets including
Brazil (NYSEARCA:EWZ), Austria (NYSEARCA:EWO), and Hong Kong
(NYSEARCA:EWH) really rallying because of the U.S.'s Fiscal
Cliff? Tell me again how fundamentally the corporations there
will be affected by it?
It's not a fundamentals driven rally and hasn't been for
awhile. We know this because the overnight derivatives
futures market, as opposed to the cash market, is the tail that
continues to wag this dog. We must therefore turn to other
data beyond fundamentals to help guide us.
Fool Me Once, Shame On You
Doing a simple Google search for news headlines the week leading
up to Christmas reveals that stocks indeed also rallied that week
because of "Fiscal Cliff Hopes".
There is just one problem with this. The Dow (NYSEARCA:DIA) was
very near its monthly highs of 13,365 at the time. Today,
even after the 12/31 "Fiscal Cliff Rally" and the 1/2 "Fiscal Cliff
Can Kicking Rally", the Dow (NYSEARCA:DDM) is once again at that
level. Buying then on Fiscal Cliff hopes would have put you
through a lot of pain before just now getting back to even.
The media it seems can find any reason in the world for a rally,
a decline, or even a flat day - anything to get your attention and
to generate noise.
We prefer a different approach that focuses on data instead of
rhetoric when it comes to investing, and that data is warning us
not to chase this rally here.
Warning Sign One - Sentiment Extremes
The media's justifications for why the market rises or falls are
always after the fact and not based on anything more than rhetoric
and possibly even self interest. The good news is we can
actually use it as one of many available sentiment gauges to help
us make more informed decisions. Bullishness abounds in the
news, but uber-bullishness is a warning sign (have I mentioned that
10 out of 10 Wall Street Strategists are projecting a market rise
in 2013?)
Analyzing investor surveys also allows identification of
sentiment levels that are more likely associated with tops or
bottoms.
Sentiment surveys are lagging in nature, meaning they reveal
information that has already been acted upon, and actually is the
reason they are reliable.
When a survey participant is asked if they are bullish or
bearish, they have likely already acted accordingly. When
survey participants are uber-bullish they have already purchased
long positions and there is less money available to chase rallies
and drive prices higher.
Right now many signs of sentiment are revealing market
participants are as bullish (and long) as they were at the 9/12,
the 4/12, and even the 7/11 market tops.
This is typically bearish because it means they have already
gone "all in long". Who is left to buy and continue to drive
prices higher?
Warning Sign Two - Show me the Money
Another data point that the market is likely closer to a top
than a bottom is the CFTC's (Commodity Futures Trading Commission)
Commitment of Traders report. The agency requires futures
traders to register as either speculators or hedgers.
Historically, speculators eventually lose and hedgers eventually
win.
The hedgers therefore are the "smart" money and following
whether they are long or short can help keep you on the right side
of the market.
Right now hedgers are excessively short. In fact hedgers
are so short, they are at levels last seen only at the 9/12, 7/11,
10/08, and 2007 market tops. This is a big bearish warning
sign.
Warning Sign Three - Technical Break Downs
In our published ETF Profit Strategy Newsletter, back on 9/21 we
identified the importance of 1430 and why if it fails a near term
top is likely in.
"We will be waiting for prices to drop back below the Fed low
of 1430 to give us a signal that the top is likely in"
.
On 10/19 in the next month's
ETF
Profit Strategy Newsletter
we again alerted readers,
"We are waiting for prices to maintain below the Fed Support
Zone @ 1430 to give us a signal an intermediate top is likely
in".
On Tuesday, 10/23, prices breached that level eventually
bottoming out at 1343 (NYSEARCA:SPY) in November where we
identified a profit taking opportunity as well as a buying
opportunity on 11/16 in our Technical Forecast.
"A break out (of the downtrend channel) likely means the
decline is over for now and prices will work their way back to the
Fibonacci retracement levels (1390-1418). A rising 60 minute
RSI lends strength to this option. This is the scenario I
think will happen given the seasonally strong days surrounding
Thanksgiving and the overall historical biases."
Price indeed broke out of the channel and reached 1410 on
11/23, a 50 point rally in a week that eventually capped out at
1448 (NYSEARCA:SSO) on 12/19.
More than two months later on 12/31 the S&P (NYSEARCA:UPRO)
closed the year at 1426 and down from the September Fed driven
rally high of 1475. After the deal rally on 1/2, the S&P
even still is below its yearly high of 1475 with little sentiment
support to drive it higher.
Now that the Fiscal Cliff worries are "behind" us, why then is
the market still not higher than it was at its September peak?
Today's Technical Backdrop
The following chart accompanied the Technical Forecast on
12/30.
Along with this commentary,
"The potential remains for another rally back into the
Fibonacci zone on Monday before a resumption of the
downtrend. If this is the case then price should peak above
1420 one more time (1424 is the R2 Pivot tomorrow). Therefore
very aggressive traders can buy a trendline breakout at 1414 (in
red in above chart) Monday morning."
This indeed occurred on 12/31 as the sharp snapback "Fiscal
Cliff" rallies provided a buying opportunity at 1414, taking prices
beyond the Fibonacci levels and back to 1454 on 1/2 for a quick
3%.
Keep in mind that this is all on the back of already extremely
bullish sentiment and no doubt those surveys will get even more
extremely bullish with the recent rallies.
For the S&P, 1398 remains a key support that bulls must
hold. If it fails, there would then be only one level left to
keep the intermediate trend from turning officially down and
increasing the likelihood prices fall below 1343.
Combining the technical picture with the overall extremely
bullish sentiment and smart money shorts, we feel the odds that the
market sees 1398 again are higher than the odds the rally will
continue.
ETF
Profit Strategy Newsletter
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