Times, they are a-changin’ – from melt up to melt down

US stocks in particular have been in a melt-up phase since at least the Christmas low with the Dow trading at the 21,500 region.  It then staged what can only be described as a ‘melt-up’ rally to the ATH at mid-July at 27,400 – a surge of almost 6,000 points in less than eight months, or 28%.

So at the Christmas low, were stocks battered and beaten down in a savage bear market where a bounce of 28% would be a normal relief rally? Not quite.  In fact, they were still in one of the longest bull markets in history off the 2009 low!

As a textbook demonstration that the market is not the economy and where bad economic news has been great for stocks, global economic data has been deteriorating fast all year and yet stocks continued their march northwards.

Of course, the prevailing theory was that the poor data almost guaranteed a reduction in interest rates to theoretically boost share values.

No matter that valuations were already in the stratosphere and major companies were in huge buy-back programmes where the CFOs of these companies are entirely price-insensitive, since their very compensation depended on pushing values ever higher into the sky blue yonder.

I am quite sure many of them were hoping they could cash in before the expected crash.  After all, most are not stupid – crazy, perhaps.

But of course, what is really driving share prices higher is the overall supremely bullish sentiment in society – and the bulls are simply taking advantage of this trend.  With unemployment rates very low, wages/salaries growing, inflation low and belief among the professionals that interest rates are heading lower and lower all pushed shares higher and higher.

It is the rolling over of social sentiment that is producing the stock turnaround.

And these are ideal conditions where major tops are put in. At tops, shares are priced for perfection, so can it get any more perfect?  Just as it feels at the top of a rollercoaster where motion is suspended before the great downward reversal takes place, shares began a steady ratcheting down in early August with the first major leg down to the 5 August low.

I must confess the resulting rally had me somewhat flummoxed with its many wide up and down swings.  But with Friday’s hard down day, I can now almost eliminate one option I had proposed – and that was a possible rally to the Fibonacci 62% retrace at the 26,500 and then hard down.

So I am back to my original roadmap as my top option:

My purple wave ‘d’ was a pretty three up in a red a-b-c and we are now in a five down in wave ‘e’.  But note the blue tramline pair I am now able to draw.  The upper tramline joins the three highs of wave ‘d’ and all I have done for the lower tramline is draw a parallel line to it and extend it forwards.

As if by magic, it cuts the 5 August low – and on Friday, the market again touched this line (black arrow), having broken sharply on Friday.  Isn’t that pretty?  Evidently, that lower tramline is a major line of support – which is what a tramline actually is.  But up until that time, I had believed a rally above Thursday’s high was likely, but it was not to be – thanks to Mr Trump and his China tariff boost.

So now the Dow is 2,000 points off the July ATH.  If my wave labels are correct, the ‘e’ wave will likely have another 4,000 points melt-down to the downside at least.

It is my belief that central banks may try to install more QE and even more negative interest rates as stocks fall but with sentiment on the wane, these moves will be treated with great suspicion as a sign of desperation – which will actually exacerbate the declines.

And at that moment, the pervading belief that central banks control economies will get eroded as they will be seen to be powerless to stop the declines.  Yes, it worked in 2008/2009 (eventually), but with debt levels multiples higher now than then, only a small increase in rates will have a massively levered effect on bond values – and forced liquidation will produce a tsunami of selling of bonds and equities.

I have noted a common theme is rolling around the MSM regarding the well-publicised Treasury yield inversions.  Most agree that it may well be warning of a recession ahead. but they also point out that stocks do not turn over until a year or so has passed.  Until then, they march ever higher.  

But could this be an exception where my ATH of July really is a major top that will hold for many years?  That would surprise the many bulls who are holding for a top a year away!

The dollar is now on the turn

I have been anticipating a turn in the dollar for a while and with Friday’s sharp reversal, I believe we are now headed lower.  Here is the daily chart

Since the February low, the market quickly surged to the 94 area but since then, the dollar has been pretty trendless with multiple waves up and down making trading exceptionally tough.  It was in Whipsaw Territory and only short term traders were able to be successful – if they guessed the next move correctly, of course. Any profits were hard-won.

But as the market started flirting with the Fibonacci 62% retrace, I started looking for signs of a reversal – and with Friday’s sharp decline, I believe I have it.  Here is the 4-hr chart of recent action

It made the 98.50 high on 1 August, then suffered a hard decline and in recent days rallied but not to a new high and on Friday, it fell out of bed.  I have a pink support line that I expect to see broken perhaps after a small bounce.  My main first target is the lower blue trendline around the 96 region.

All year, sentiment towards the dollar  has been bullish as data-driven traders note the 2% yield on Treasuries opposed to a negative 0.4% on the euro.  In addition, the EZ economy is slowing while the US data remains generally decent.  So the case for the dollar is water-tight, is it not?  So why am I not bullish the dollar like almost everyone else?

Last week, the DSI bulls reached the 90% mark – a near record and from where previous turns have been made. Whenever the bulls reach 90%, it only takes a small cohort to sell and the effect is huge as there are few buyers around (they have already bought).

Remember, the news follows the markets.  Most believe the opposite – and these are caught holding wrong-way bets at major turns.  If you trade against this herd, you stand a very good chance of taking major profits from them – provided your timing is right.  And there’s the rub…

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