Last week, the Dow declined by 1,600 points in just four days. That was not quite the record of 2,400 points weekly decline earlier in February, but it was in the same direction – down. I hope that gives a clue which direction the stock market is now headed.
I managed to locate the high of the great bull market in January and also to pinpoint the relief rally high at the 25,800 top on 27 February where we entered new short trades anticipating a hard down in a third wave. And last week’s action has helped verify my outlook for much lower prices ahead.
Working under the surface all through the bull market was the steady rise in US interest rates with a very visible rise in Treasury yields of all maturities. In fact, VIP Traders Club members have enjoyed riding the T-Bond bear market for some time (since July 2016, in fact).
But in tandem with Treasuries, the LIBOR short term bank-to-bank lending rate has been quietly (to most traders) moving up sharply, and especially in recent weeks
In fact, it is now at a ten-year high (from 0.3% in late 2015) – at a 2% level last seen just before shares fell off a cliff in the great Credit Crunch wipe-out that ended significantly lower at the March 2009 lows. Hmm.
Remember, LIBOR is a bank-to bank unsecured rate and higher rates inevitably spill over into consumer rates very quickly. And as in 2007 – 2008, rising rates indicate banks are getting more nervous about lending to another bank as they are less confident of the security of their funds. This does not bode well for business, or for stocks whose valuations have been based on ZIRP for ever.
Clearly, the Fed is seeing which way the wind is blowing and following these rate rises with the frank acknowledgment of the new Fed chief Powell that there will be several rate hikes this year. So after months of rising rates, the stock market suddenly had a Wile E Coyote moment on January 29, looked down and realised it is a long way to the canyon floor. Shares cannot be suspended in mid-air by hope for ever!
As I have repeatedly warned, when the fifth waves of many degrees were complete at the top, the way was clear for an historic bear market. The historic top was the January 29 high at 26,705.
This is the updated weekly chart showing the big picture
Recall in early February the market plunged in a wild sell-off, but was stopped right at the upper tramline in a textbook kiss. That demonstrated the reliability of that line to act as support (was resistance until September).
And what a perfect demonstration that markets have memories! It ‘remembered’ where an extension of the tramline was in price (but not time) and acted as an invisible line of support into the future. I find that remarkable and perhaps it has something to do with the nature of the market, which is a publicly traded financial instrument with a vast array of participants whose personal fears, avarice, needs and wants range all over the map. But I digress…
Of course, the February plunge brought out the usual suspects of dip-buyers who waded in with both feet – only to be monkey-hammered last week with that 1,600 point crunch.
Here is the close-up
The lead-up to the January high is a classic Head & Shoulders reversal pattern. I have extended the neckline into February and lo and behold, the relief rally just touched it in a kiss. Regular readers will know what happens after a kiss – yes, a Scalded Cat Bounce. I should really call it a Poisoned Kiss because the market then pulls away very hard, as happened last week, as it is repulsed by the resistance.
I cover this and many other useful patterns in my book, Tramline Trading (available on Amazon, of course).
Another factor that helped me identify the wave 2 high was the rally has carried to the Fibonacci 62% retrace – the most common level where turns are made.
So now we are in wave 3 down and this wave promises to be brutal (to the bulls). The severity of last week’s decline has put the market oversold in the short term, but any bounce should be reversed very quickly.
On Monday, it will have a chance to react to the Italy elections and if ‘bullish’, we could see an extension of Friday’s bounce. But the main trend is now down and that is the way I am playing it.
The gold decline may be on hold
I have been playing the short side of gold/silver, but recent action has thrown much doubt on my bearish stance. It often happens that the signs from the chart are reasonably clear-cut, but then reality intrudes a little later to cloud the picture. And I believe we are at such a juncture now.
Here is the short term picture
I have been short from around the $1350 area and was proved correct as the market declined into last week’s low. By then, I noted the clear five down aspect of the decline. If I apply the Elliott wave labels above in a simple A-B-C (which is always counter-trend), the implication is the the main trend remains up.
I have a three up in wave B and a five down in wave C – both textbook (wave A is more complex). And if this is correct, waves A and C are of equal height – a common Fibonacci relationship.
And if stocks fall hard, will there be a delayed flight to gold’s safety, as is common in these circumstances?
I have been keeping protective stops at break even – as is my custom – in case a rally materialises but I am tempted to cover shorts on further strength. Such is the constant dilemma of a trader!
Next week should prove pivotal.