Should you Buy this Dip?

This will be a brief blog this time as I will be taking a short weekend break.

Stocks rallied as forecast from the deep lows of the week before as the algos filled their boots after the Fed cut rates by a large 50 bps in customary knee-jerk fashion.  And that’s what they are programmed to do – in all circumstances.

But what if this was a Dead Cat Bounce? What if the game has changed?  What if the growing fear of a pandemic is starting to trump the Fed’s machinations and thus short-circuit the algos’ buying strategy?

Algo trading dominates actions of the big boys.  It is a product of Artificial Intelligence.  As such, it learns to make trading decisions based on its experience.  For years, that experience has taught it to Buy Dips.  The positive results from that policy has solidified all future decisions in that mode.

So when market conditions suddenly change, it is totally unprepared to amend its system of buying dips.  If markets have indeed turned down, the algos will need a few major losses to learn the new rules.

That means that as the markets decline, the algo buying will be forced to sell, thus adding to the waves of selling pressure as they limit losses.

In other words, the current algo trading scenario is perfectly set up to produce very sharp declines.

Not only that, but the market’s reaction to the Fed rate cut was extremely negative.  The Dow fell 1,000 pips on Thursday.  The Fed has stated the US economy is great, yet it cut – as an ’emergency’ manner – by the largest amount since 2008.  Prior to that, an ’emergency’ cut of this size was at the time of the greatest market decline since 1928 just ahead of the Great Depression.

Of course, at the start of every major decline, the authorities always try to calm the markets with soothing words.  That is surely one of the most secure contrarian indicators out there to pinpoint the start of a collapse.

The dollar renews bear trend

If there is one market that holds the key to all the others, it is the dollar.  The value of the dollar as the global reserve currency where world trade is mostly conducted, is critical to the supply/demand balance of anything that is internationally traded.  That is why I spend so much time analysing it.

My long-standing forecast has been for a weaker dollar.  And the latest Fed action fits that scenario like a glove.  But the most important feature I look for is the state of the charts – and sentiment.

I had been waiting a long time for the 2019 rally to terminate.  All of last year, the dollar was heavily bought as the relatively high US interest rates seemed impervious to the ZIRP and NIRP policies of the ECB.  That made US bond investments a lot more attractive than counterparts in Europe.  Yields in the EU were strongly negative – and who wants to lose certain money on a ‘safe’ bond investment that is supposed to produce a yield?

Of course, that’s a silly question as multitudes of investors clambered over themselves to scoop up the negative yielding bonds on offer. I mentioned recently that Greek bonds were yielding less than the 10-yr US Treasury as a prime example of the Alice in Wonderland madness currently in the fixed interest world.  Pure madness when seen through the lens of acting in the beat interests of investors.  There are few investors I know that relish losing money.

One day, this will be seem as total folly in the same league as buying Lehman Brothers bonds in 2008.

But with recent DSI bullish reading for the euro around the lowly 10% mark, the current sentiment picture is totally compatible with a euro rally/dollar decline.  I expect fireworks in this market.  In fact, they have already started with a sharp reversal last week.

See what I mean?  The reversal off the wave 2 low last month has been vertical, as I predicted.

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I fully expect even more dramatic action next week with the coronavirus taking up most the MSM headlines.  But the incipient pandemic is simply the result of a general weakening of our immune systems following a move to more negative social mood (see last week’s blog).