The bull trap is closing. Now for the carnage.
Since the mid-October lows in the indexes, stocks have rallied sharply on bullish expectations for 2023. These have been based partly on what the Fed may do to temper their rate hikes on the back of falling inflation. This new-found optimism from the depths of despair in October is now deeply entrenched – and is about to be sharply reversed as real world economics re-asserts itself. Now, bad news really will be bad.
Of course, in a real sense, how can anyone hook a cause-and-effect ‘reason’ to a a partucular market action? These justifications arrive after the event. If shares had continued their sharp decline after mid-October, we would be writing about how the Fed was ramping up rates to kill market speculation in a mea culpa to the QE speculative monstrosity they aided and abetted from 2008.
One telling MSM headline tells it all: “This bargain fund offers investors a chance to own tomorrow’s winners“ Translation: The shares are cheap and when the coming recession is over, they will soar just as Tesla did. You may have to live through a period of weakness in the recession, but sunny uplands await. Jam tomorrow!
If that is not a sign of unrelenting optimism, I do not know what is. If he/she believes they will decline further, why not wait to buy? But no, buy now (since my bullishness is boiling over!). No problem if your shares fall – just hold ’em.
In the coming decline, this strategy will be sorely tested.
Here is another one from another prominent guru: “The stock market’s bargain basement is a good place to get rich“ Yes, the desire to get rich from investing in shares lives on but will die a very clow death. But the day when investing in cash is coming as rates rise. For most investors, they will do this too late.
But Wall Street has just belatedly heard the penny has dropped that interest rates are climbing – and are at multi-decade highs. Stocks climbed excessively in the era of cheap and ‘free’ money (see Tesla – which now is down a Fib 62% from ATH) but is it rational to believe they will continue to do so in this new era of very expensive money and tighter conditions when many are carrying huge debt loads?
They will almost certainly swing too far the other way when the bear market is over. That will be the time to go looking in the bargain basement, certainly not when the FTSE is close to its ATH.
Already this tight money effect is starting to flow through to the real estate sector with several REITs (Real Estate Investment Trusts) and other funds seeing vast outflows of capital so much that some have been forced to pause redemptions.
And for the first time in decades (and probably ever since the Fed was established on 13 December 1913, please note the date – exactly 99 years ago), its balance sheet showing its assets have started to contract from the titanic $22 Trillion high). Significantly, this high was set about a year ago – and neatly coincided with the ATHs in stock indexes. That is no coincidence.
And the Fed’s policy of reducing its asset base (aka selling bonds) will put even more pressure on shares and assets of all stripes (especially real estate). It may even reach to the currently hot vintage car market.
In effect, the Fed is now being forced by markets to deflate the enormous bubbles they helped to create with their ultimately destructive time-bomb QE policies. It will not be pretty.
This current irrational exuberance is also shown in a recent Bloomberg survey of top US money managers showing that 71% expect equities to rise in 2023 versus 19% who expect a decline (10% are neutral).
But already latest data is pointing to a continued slowdown in the global economy which precisely follows the rule that the economy follows the stock market. This runs counter to the usual cause-and-effect model put out by almost everyone. The market leads and the economy follows.
Just released, the S&P Global Flash PMI for December is 44.6 – the lowest since 2020 – and a print under 50 indicates contraction. This is already a deep recession – and will get even deeper next year. Soon, analysts will be talking about a depression, which I have long forecast.
But virtually no-one is using that term yet. Here is a simple Google search for the term ” economic depression” for the past three years. It spiked up during the March 2020 Corona Crash but only to 100 a day. Since then, no-one has been interested in worrying about a coming depression. I have most definitely been in the minority!
That is another clue that almost total complacency about a possible crash remains. I foresee the daily search rate will zoom well above 100 next year.
Note the number of searches is now edging upwards. Hmm.
One other sign of almost total complacency about a stock market crash is the VIX ‘Fear Index’. This index is based on moves in S&P options (in a complicated way). But it has consistently tracked up/down expectations in the stock market and today, it is at a very low level of fear
It sits at the lower edge of the 2022 pink trading zone around 24 as the S&P has retraced approx 50% of the move off the October wave 1 low. And at these current low levels, the DSI (Daily Sentiment Indicator) reading shows an 84% bear reading which is at the same low level where previous stock highs have been made.
Of course, stocks could move higher into new highs next year as the bulls fervently wish, but the odds are firmly against it. And that is what we all do as traders – make judgements about the odds of various scenarios playing out. And sometimes, the odds are just too tempting not to trade!
Does anyone else find it strange that the FTSE 100 is trading within 95% of its 2018 ATH of 7900 all the while the nation is in the grips of waves of strikes, a cost-of-living crisis, political turmoil (three PMs this year) and a general sense of gloom among the public?
Of course, this index is dominated by resource companies whose shares have been in bull trends as they earn in dollars. But consumer-facing firms are suffering, such as supermarkets.
I believe even the high-flying mining/oil companies will start to feel the effects of the global slowdown in 2023.
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Has the dollar finally turned back up?
Until September, the Almighty Dollar was King reaching the 115 zone – a level last seen in 2002, twenty years ago. That was when the Dow traded at a lowly 10,000! But since the Autumn, it has been in a savage decline which has worked off the extreme bullish froth when everyone and his/her dog were into the greenback.
Now with DX down to the 103 region (a major loss of 10%), sentiment has turned bearish. For instance, the COT data shows hedge funds are over 2/1 long the euro (which is the major component of DX).
On this daily chart we have a very rare expanding wedge. To be frank, I am not sure what this pattern implies, but when the market broke down out of it on 10 November, it heralded a further decline. And last week it did just that to the Fib 50% retrace of the previous wave and on a crucial mom div. Here it is on a closeup
And the stand-out feature in the decline is the ending diagonal (in five sub-waves) on not only a mom div but also an RSI div. The clear implication is that when the market pushes above the diagonal, it will very likely power a substantial rally.
So how far can this rally carry? In the top chart I have the September high as a major third wave. That implies an eventual move to new highs in a fifth wave to above 115.
But in the lower chart I have the September high as a major fifth and final wave. That implies any rally now will not move above the 115 high but is in a second wave relief rally.
Either option is acceptable as it stands and I must monitor the sub waves as they unfold to glean clues as to which is likely to prevail.
VIP Traders Club members are already positioned for either option and are long DX.
We are there now
Two weeks ago I posted my blog with the headline If we are not there yet, we are very close. And last week, the balloon was pricked with the Dow off by over 2,000 pts from Tuesday’s spike high. So what happened to ’cause’ this reversal?
Conventional pundits will claim that investors have suddenly turned way from the bullish narrative that the Fed will ease up on rate hikes next year as disinflation now rules (oil prices weakening). They now are paying heed to the almost certain recession that lies ahead with slowing earnings growth with high bond coupon payments, apparently.
But that is just making up rationalisations for market action that has already occurred. Totally useless for price forecasting. Of course we all love a compelling story and that is why conventional pundits are thick on the ground. There are very few (good) technical analysts that feature in the MSM.
So now we have started on the long road lower to my main bear market targets. But it will not be straight down. Here is a very viable short term roadmap on the Dow
In spread betting it is essential to manage your trade entries and exits as accurately as possible knowing that a few hundred points the wrong way can take you out on your stop even thought you have guessed the main direction correctly. Also I advocate trading in and out of at least part positions to grab profits and that is what we do in the VIP Traders Club.
And that is why I advised members taking some profit yesterday near my wave 3 low in anticipation of a small wave 4 bounce next week (where I will be looking to re-enter shorts if that occurs).
In the unlikely event the rally will carry much farther, we have protection with buy stops at our entry price – and have at least taken some profit yesterday. This is now professionals use good money management – I recommend it to all.