Does sentiment trump the data?

Pundits have been scratching their collective heads for so long they surely must not have much hair left.  Why?  They just cannot get their heads around the madcap behaviour of stocks when compared with the fundamentals of the economy.  Seekingalpha.com is full of such anguish.

I get a great deal of entertainment out of their frustration as they try to square the circle using the old conventional paradigm of the markets follow the news/fundamentals.  Long-time readers will know that they have the cart before the horse here.

Economic data figures are always and everywhere backward-looking and cannot help predict turns – unless you take into account sentiment.  Conventional thinkers believe action creates sentiment.  In reality, it is the reverse. In addition, it is the human mind that interprets what the data mean – and all humans have biases, especially the ‘experts’.  For instance, a small US job creation figure could have different interpretations.  It could imply the economy is slowing, but in the current era of  central bank control of money supply and negative interest rates, that could have two equally rational opposing interpretations.

A slowing economy would imply the Fed wants to delay raising interest rates to prevent another crash developing – clearly a positive for immediate stock market action.  On the other hand, a slowing economy is always bad for stock market earnings, right?  Which side someone comes down on will depend on their bias or personal preference – and that is something no economist can predict.  And we can all change our minds (a rare event among economists, admittedly).

There is no doubt that the US economy has not even come close to reaching lift-off following the historic Keynsian ‘stimulus’ unleashed by the Fed since the Credit Crunch Crash of 2007 – 2009.  We have seen some truly dreadful reports recently.

But that hasn’t stopped stocks running ever higher from the February lows.  And that is the result of improved sentiment, which is the ultimate driver of markets.  And that is why I spend so much effort in analysing the various sentiment readings.

Brexit sentiment is volatile

But as sentiment around Brexit has swung around depending on the ever-changing poll results, this is what the FTSE has been doing:

Yesterday, new polls were suddenly putting Leave ahead of Remain and the market’s knee-jerk selling brought the index ever closer to my shelf of support around the 6050 area.  But the decline was on the cards already from the previous pattern of an A-B-C counter-trend rally to just over the Fibonacci 50% resistance level on a momentum divergence.

It is the chart patterns that determine the next likely path.  Remember, we are dealing with probabilities, never certainties.  As traders, we always want the odds on our side before acting.

COT data reflects honest sentiment

And the COT data is one of my key inputs.

This is an actual count of the number of long and short futures positions held by the three main participants in each market.  It is compiled weekly and released on Fridays.  The main drawback is that it is already three days late when released – and a lot can happen in that time.  But its great strength is that it records the strength of honest sentiment where real money is on the line.  Surveys are opinions, that is all (but still useful at extremes).

Here is a great current example in USD/JPY.  Mainstream opinion is that the yen will strengthen as they believe (hope?) that Abenomics will finally prod the highly deflating Japanese economy towards their long-cherished – but forever missing – 2% inflation rate. The latest encouragement is the news that the planned sales tax increase will now be delayed.

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I posted the page last week as the market has declining to the $1200 level and forecast a recovery off that level.  That has indeed occurred.  If you want to know where I believe gold and silver are heading, join my VIP Traders Club here.

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In its deflating economy where the Debt/GDP ratio is now over 200% and climbing and with a rapidly ageing population as they spend less, the battered can is being well and truly kicked down that long and winding road.  It is just a matter of time before the game is up and markets will turn with a vengeance.

And to add to the bulls’ rationale, they believe Brexit would somehow induce a flow of funds out of the UK back to Japan with consequent yen demand.

Here is the latest COT data of yen positioning:

This is a bombshell report.  It shows that in the week to 7 June, hedge funds (managed money) bought yen/sold dollar in staggering amounts equating to an increase in longs of over 50% in one week.  No matter how you slice it, that is a titanic increase in bullish sentiment in a major currency cross.  At the same time, the commercials (smart money) were happy to take the other side.

What is the context of this monumental move to the bullish camp?  Was the yen making new lows and hedge funds spotted a bargain?  Have they re-discovered the age-old principle to Buy Low. Sell High?  Of course not; it was the reverse – the yen was already rising sharply (USD/JPY lower) and they were chasing the trend (their favourite trading style).

Naturally, when hedgies all slide over to one side of the boat, I will look very hard at the attractions on the other side in true contrarian fashion.  And what an attractive setup I see!  Here is the long-term chart:

The stupendous rally off the 2012 lows (much of which we caught) is in a textbook five up with a textbook triangle in wave 4 (a classic five wave affair) and an internal five impulse waves in the final fifth wave to the 125 top with a large momentum divergence.

And with that top in place, what do we all expect using our basic Elliott wave knowledge?  Yes, a three down in an A-B-C.  And lo and behold, that is precisely what we were given – with the C wave resting right at the Fibonacci 38% support level.

With the market at this critical stage and given the extreme yen bullishness of the hedge funds, odds are very high that we shall see a recovery in USD/JPY.

Of course, on the other side of the ledger, USD has been weak on the idea that with the weak jobs number last week, the Fed will be reluctant to start raising them just yet, despite the highly conflicted utterances of Fed members.  We shall know on Wednesday (perhaps).

With the background impulse for higher US rates and still lower negative Japan rates, the scene is set for a monumental reversal in USD/JPY.

I have positioned VIP Traders Club members long USD/JPY.