-- Weekly Market Summary --

Odds of Stock Market Rally are Higher than Most Expect

By Joe Duarte for September 11, 2017

Investors have been pricing in a major decline in the stock market by avoiding stocks, buying gold, and selling U.S. treasury bonds along with the U.S. dollar. But, as history shows, when everyone is betting on one thing, the opposite is often what happens. What it means is that we may be at one of those turning points in a mad, mad, world where the robots sell other assets and buy the dip in stocks yet again.

In the past, extreme readings in market indicators such as equity valuations, soft economic data, and the general state of the geopolitics combined with technical analysis were reliable gauges of market turning points – not so much today. So what’s changed? A large volume of the market’s activity is being generated, not by human traders, but by robot algorithms programmed to read headlines and to execute billion dollar trading programs based on the content of the headlines and simple technical analysis. More important, once they’ve acted on the headlines, the machines often reverse their initial strategies at key technical price levels, leading to rapid changes in current price trends.

Yet, their machine like precision can be useful, given their propensity to follow simple and predictable scripts. In other words, most of the time, to the machines, good news is good news, and bad news is bad news. And when they reach key technical support and resistance levels, they will always follow the rules and reverse their current strategy.

In the next few paragraphs I will review four major markets and how their interactions may lead to a significant rally in stocks.

Market Sentiment is Bullish

Let’s look at the market’s sentiment gauges. First, the CNN Greed and Fear Index delivered its most recent reading of 38 percent. It was the mid 20’s a few weeks ago and the market rallied. This is bullish. Second, the CBOE Put/Call ratio for equities is at 0.73. That’s not a blockbuster number, but it is meaningful since it was the highest reading in ten days, where the previous nine readings were in the high 0.5 and low 0.6 range. This is a measure of the retail option traders and it shows they are starting to get concerned. This is bullish. Even better is the CBOE Index Put/Call ratio, which measures institutional fear. This number was 2.08 on 9/7/17, falling to 1.1 on 9/8. Both index readings are high numbers, which means rising fear from big money players such as mutual funds and likely insurance companies worried about losing their shirt when the hurricane claims start flooding in.

Bottom line: bull markets love to climb walls of worry. And we’ve got a nice one rising at the moment.

The Big Four Are Connected

With bearish sentiment for stocks rising, looking at price action in the markets becomes critical, which is why I have included the following

levels, they will always follow the rules and reverse their current strategy.

In the next few paragraphs I will review four major markets and how their interactions may lead to a significant rally in stocks.

Market Sentiment is Bullish

Let’s look at the market’s sentiment gauges. First, the CNN Greed and Fear Index delivered its most recent reading of 38 percent. It was the mid 20’s a few weeks ago and the market rallied. This is bullish. Second, the CBOE Put/Call ratio for equities is at 0.73. That’s not a blockbuster number, but it is meaningful since it was the highest reading in ten days, where the previous nine readings were in the high 0.5 and low 0.6 range. This is a measure of the retail option traders and it shows they are starting to get concerned. This is bullish. Even better is the CBOE Index Put/Call ratio, which measures institutional fear. This number was 2.08 on 9/7/17, falling to 1.1 on 9/8. Both index readings are high numbers, which means rising fear from big money players such as mutual funds and likely insurance companies worried about losing their shirt when the hurricane claims start flooding in.

Bottom line: bull markets love to climb walls of worry. And we’ve got a nice one rising at the moment.

The Big Four Are Connected

With bearish sentiment for stocks rising, looking at price action in the markets becomes critical, which is why I have included the following five charts. I recommend you review them all in relationship to one another, and note how the turning points in one market often correspond to the turning points in another. This is particularly noticeable in the dollar, gold, and bonds. First, let’s look at the NYSE Advance Decline line before we look at The Big Four: SPX, ten year bond yields, gold, and the U.S. dollar.

Regardless of the recent increase in volatility, the NYSE Advance Decline line (NYAD) recently made a new high and is within reach of another one and perhaps a series of new highs should the market rally. This is not what happens before a market crash. So stocks may still reverse, but that remains to be seen given the positive posture of this highly reliable indicator. Indeed, the current pattern in the NYAD is eerily- dare I say it, digitally similar to the March-April bottom and subsequent rally.

The S & P 500 (SPX) is in a consolidation pattern waiting for a catalyst. But it is trading above all key moving averages and recent support levels. Moreover there is no overt negative bias in its Accumulation Distribution (ADI) and On Balance Volume (OBV) indicators, while ROC, which measures momentum, is also neutral. Meanwhile, the Bollinger Bands (Green lines above and below prices) are starting to close in, which is a sign of a big move coming. All that is required is a reason to move. Headlines anyone?

The U.S. Ten Year Bond Yield (TNX) has been falling precipitously. This is a sign of investors (robots) expecting a slowing in the economy based on the recent headlines – politics, hurricanes, and less than robust economic data and employment growth. More important, it’s a sign of a big bet that the Fed won’t be raising interest rates any time soon.

Gold prices have been rallying, as the robots respond to the same headlines that have driven bond yields lower. In other words, the robots have been betting that easy money will continue to weaken the dollar, and that this will eventually lead to inflation while the Fed remains handcuffed and can’t raise interest rates due to weak economic activity.


Finally, the U.S. Dollar has been clobbered lately, again based on the same robotic conclusion that the world is nearing some type of meaningful political turning point and that the U.S. economy is slowing enough for the Fed not to raise interest rates.

The robotic conclusion is simple enough – perhaps too simple. The economy is slowing, the Fed won’t raise rates and cheap money will persist and be inflationary. Yet, these trends have been in place for a few weeks. And with all three markets trading outside their respective Bollinger Bands, the odds of a reversal to the means are rising.

Reversal in Bonds, Treasuries, and the U.S. Dollar Leads to Stocks

The combination of fairly sound action in the NYAD, less than terrible action in the SPX, rising gold prices, a collapsing dollar and rapidly falling bond yields suggest the robots and their handlers are betting the hurricanes will weaken the U.S. economy further and the Fed won’t raise interest rates. And they may be onto something, fundamentally. The problem with this all or nothing conclusion is that those three markets are very much overbought. Thus a reversal in gold, the treasury markets, and the dollar is very likely. This, in turn, will leave a lot of money floating around.

The entire circular dynamic brings us all back to the dominant trend of the past eight years - low economic growth combined with easy money – and yet another up leg in the stock market. So this is a tricky time during which being calm and remain hedged is required. If I’m right, the dollar, gold, and bonds trends will reverse and the money from the selling in those markets will find its robotic way back into stocks, where the same old dynamic will be back in play.

What could go wrong? Everything of course, but more specifically, if North Korea pushes the button or if the Fed decides to raise interest rates, all bets would be off. Furthermore, the hurricanes –Harvey and Irma – may leave something unexpected in their wakes that has not been factored into current market prices. In any of those circumstances, Chaos would turn into Disorder and I suspect the bots won’t know what to do. That could be the time when the billions in derivatives that are out there lurking would trigger margin calls among the big money boys, creating even more waves of volatility and disorder. Otherwise, regardless of what common sense and a general feeling of self preservation would dictate, the odds favor more action to the up side in stocks.



 

 

















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