Weekly Wrap

When I started trading, I did what virtually everyone else did in a roaring bull market.  I became even more bullish!  Wow!  If the market can get to 16,000 from 6,500 in only less than five years, who knows where it will be in the next five years?  Surely at this rate, it can reach a similar multiple to 40,000- maybe even higher.  After all, the economy is getting much better (see latest data).

Everyone else is buying, which means I am truly a first class mug not to join in, and I sure don’t want to be missing this sure-thing boat.

Believe it or not, this is the very process that operates in the stock market today (and since the beginning of time) – even among professionals.  It is called herding, and we see it everywhere from fans of pop ‘stars’ to football team fans to political parties to central bank actions to Bitcoins (now over $1,000!) – the list is endless.

Joining a herd gives you the warm fuzzy feeling of belonging – and that is a basic human need.

But it is a killer in the markets.

Such a need to belong in a group of like-minded people can easily shield you from seeing and acting on a turn around, which inevitably will come.  And major tops are made when bullish sentiment is at or near an extreme.

This human imperative is similar to what goes on in my dog’s brain.  She loves to chase squirrels.  Every day, she runs after at least one, but has never caught one yet.  This experience of failure has not deterred her – she still clings to the ancient inherited basic instinct – if it is small and furry and moves, chase it!

It is the same in human brains.  If it is moving up – buy it!  You can always rationalise a good reason later.

The investing world is full of gold bulls that are still holding their ‘investment’ after a 30% drop from the 2011 top.  They still cling to the same beliefs that propelled gold in its bull run, even though these inflationary factors are clearly not relevant today (although they may be in the future).

But why did they buy in the first place?  Most bought as a speculation, pure and simple.  It reminds me of the age-old definition of an investment – it is a speculation that went wrong.

I remember running into a chap that had bought gold in the late 1970s as he was caught up in the bullish mania.  He was still hoping a few years after the historic 1980 $850 top for a magic turn back up.  He had a very long wait to be made whole – 25 years in fact.  I’m sure he lost interest in the meantime.

Actually, this was one early experience that made me train myself to become a contrarian and be more bearish as the market rose because I know that when the market runs out of buyers, the selling will be intense, and stock markets fall faster than they rise.  And the turn would be marked by high bullish sentiment.

And yesterday, I believe we are close to running out of buyers in US stock markets.

(chart courtesy Elliott Wave International)

This II measure of bullish sentiment is at a 26-year high.  It is even higher than at the 2007 top, which preceded a 55% collapse in the Dow.  The potential for an even bigger percentage decline is high.

Just look at the recent melt-up – it is almost vertical, and is steeper that any other recent period.  This is a give-away to me that the end is very much nigh, and the turn will be vicious when it arrives.

But here is an intriguing thought – has the turn already been made yesterday with virtually no-one looking, as the world and his dog was out shopping on Black Friday?

Here is some evidence – and it comes from the very short-term charts.  Here is the S&P:

This is the recent rally leg and shows a clear five up with a terrific trendline.  Counting the height of the w3 high from the base, we get a height of 62 handles (surely a coincidence as the inverse Golden Mean is 0.62?).  Applying a multiple of 0.618 to this as we get 38.3.  Add this to the w4 low and we get a target for w5 of 1815.3.

This 0.618 multiple of w1-w3 is a common Fibonacci relationship with w5, and  often gives a target for the w5 top.

And the high on Friday afternoon was 1813.3 – only two handles shy of target.

Not only that, but the whole last part of the wave structure has been accompanied by a huge negative momentum divergence, indicating a weakening of buying power going into the high.

On yesterday’s close, the market is resting on the trendline – a break of which will be hugely significant.

But what is happening over in the Dow?

The leg up from the 9 October low is a wedge (or rising diagonal) – and in the last hour yesterday, the market broke out of it (while everyone was shopping).  That was sneaky.

But I believe is significant.  Note the break was in the Dow (risk off), while in the risk-on S&P there is no break yet, and in the high risk Nasdaq well, what can I say?

A rising diagonal in the fifth wave position is one of the most powerful precursers to a massive decline.

And here is the latest Dow COT:

Hedgies have turned markedly more bearish with a 25% swing to the bear’s camp last week.  I know I like to do battle with hedge funds, but this is surely a warning that the bull’ s days are surely numbered.

We are in a stock-buying mania and even the no-hopers are being snapped up.  Did I mention mania?  For a world-class mania, look no further than Bitcoin – it has rocketed up this month to over $1,000.

Next week should be interesting as traders get back from the stores and see the Dow break.

GOLD

In recent posts, I have been putting the case for a turnaround in gold.  Here is the monthly chart with my EW labels:

Sentiment is horrible and is a mirror image of the situation in stocks.  Funds have been rushing out of gold ETFs and into stocks.  Prominent pundits have been falling over themselves getting their ever-lower targets out.

But just look at the momentum – I do not recall it ever being so extreme on the downside.  It closely matches that attached to the 2011 high – and we all know how one that resolved.  I believe the potential is very high for a huge counter-trend rally in a large w4 – perhaps up to the recent high at $1435 – or higher.

This rally would fit in perfectly with a decline in stocks in a hard risk-off swing.  Hmm.

I have said that I expect the next deflationary wave to come from Europe – and I say that money supply is falling at a rapid rate in the eurozone.  Not only is this highly deflationary, but with money and credit dropping, bond defaults are a few steps closer.

EURO

Is coming to the end of its counter-trend rally as it kisses my tramline:

It has also just made a Fib 62% retrace of the leg down off the 1.38 high.  And the rally is an A-B-C.  What more do you want?  This is a textbook scenario.

APPLE

Has been one of the leaders of the Nasdaq pack, but have we reached a turn?

I have a wedge (another one!) and market has made a Fibonacci 62% retrace off the $700 high.  Bullish enthusiasm is back in spades, so I ask the question – is this as good as it gets?

Have a great weekend!