It has been said that the stock market is a discounter of the future, and in that role perceptions about the future drive prices more than current news, or reality. This is a difficult notion for neophyte investors, and for some professionals I’ve known down through the decades, to fully understand. The financial media with its focus on earnings, or changes on the board of directors, or a scandal involving the CEO of a major corporation, tends to make investors believe that reality means more than the fuzzy domain of perceptions about the future.
However, the record setting decline beginning in February is testament again to the power of perception in the process of price discovery in the stock market. The perception at the low on March 23 was that the Administration, the Congress, and the Fed would once again come to the rescue just as they had in the post 1987 crash, the bursting of the Tech bubble in 2000-2003, and the fears of a Great Recession, or new Depression, arising out of the 2007-2009 financial crisis. The perception of another government rescue, the arrival of renewed animal sprits common with the onset of the spring season, and the abatement in the Northeast of new COVID-19 cases, resulted in investors embracing the “V” shaped recovery theory being hawked by the powers that be.
Perception, which has driven the powerful rally off the March 23 low higher than experience said were reasonable rebound targets, has now become reality. And, during this past week that reality became as good as it gets for the bulls, when Fed Chairman Powell declared that the Fed was buying corporate bonds, and essentially the Fed was going full court press to support the markets. So now perception has become reality, and will the new current reality drive price discovery, or will a new perception about the future?
The rebound rally peaked at S&P-500 3233 with in five points of painting out a perfect Fibonacci .618 relationship between the second leg up in the recovery rally and the first leg up. This was shown in last week’s update. Some of us have seen this happen before at various “degrees” of trend, and in the current case provided a strong hint that the unprecedentedly swift bear market decline likely had not ended at the March 23 low, but rather perhaps only the first leg down had ended.
The 3233 high was followed by an impulsive like decline, and then another rebound attempt into this past week. The dull sideways trading of this past week has added some more evidence for the bear case, as the bounce following the renewed weakness could to-date only fill the gap, which formed as the impulsive like decline broke away from the 3233 high. Screenshot-132 above shows this gap with a shaded ellipse. The bulls made two attempts to power to new recovery rally highs above the 3233 level, and both attempts failed in the gap. The open on Friday hosted the second attempt, but almost immediately sellers began to take the market lower with steady selling.
Alexander and I took Chairman Powell’s comments to mean that the Fed was so seriously concerned about the fragile state of the economy, that a decision had been taken to go all in, and to let the markets know not in the usually obscure verbiage of Fed speak, but directly an unequivocally. So the markets got all they could possibly hope for from the Administration, the Congress, and this week the all-in Fed, but the price failed to best not only the 3233 rebound high, but also failed to best the high of the previous test of the 3233 high, when the price failed not once, but twice in the gap depicted above by the ellipse in Screenshot-132. In an environment of extreme bullish sentiment investors get the best possible news from the most powerful financial institution in the world, and the price fails to respond with new recovery rally highs. So, what is left to drive prices higher?
A case can be made that perception of an extremely quick “V” recovery for the economy and the stock market compliments of the Administration, the Congress, and the Fed has driven investors back into the stock market resulting in a euphoric extreme even greater than at the all-time high. Perception has now morphed into the reality that the Fed is an all-in Fed, and in the way the markets actually do business the former positive is now morphing into a negative, potentially a huge negative, as the Fed has now set up a potential demonstration of its finite powers, just when investors have placed their trust in the Fed having unlimited powers. The conditions appear to be coming together for a new market driving perception about the future.
TATY — A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown above in Snapshot-359 in yellow with the S&P-500 overlaid in red and blue candlestick chart format.
TATY finished the week at a relatively unchanged 109, which is an oversold level. TATY continues to suggest the rebound rally may be a trap for the bulls, as it remains oversold for a record length of time. And, has failed completely since the March 23 low to lead the price higher with a gravity like pull. Given TATY’s previous record of accuracy, then one must respect that its continuing warning of outlier conditions may be a clue to be taken into account, and that the bear market may have not end on March 23. No indicator is perfect in this game of probabilities, and what is happening now may be a rare miss for TATY, but given the failure of the recovery rally to make new highs on the best possible news, then the consistent warnings from TATY may prove to have been prescient?
THE BOTTOM LINE
Perception has morphed into a new reality vis-à-vis the Fed, and the recovery rally to-date. It would appear that the stock market may now be searching for a new, and updated, perception of the future to drive prices. Given the bullish sentiment extremes reached as the S&P-500 peaked at 3233, a case can be made that current financial stimulus conditions are as good as they can get, and an emerging new perception may result in a vulnerable market, which even may be poised for a plunge.
The first “tell” that the recovery rally may have expired at 3233 would be a close below S&P-500 3070-3075. Should such an event occur, then investors may become a witness to an accelerating decline, which may or may not pause at support levels, which will be posted in these weekly updates. A rally above S&P-500 3233 would suggest a possible assault on new all-time highs, and that the bear market ended at the March 23 low. At the moment the bear case implies great potential risks for wealth destruction, more than the bull case implies for risk adjusted reward, so until evidence to the contrary arrives, we are going to continue our preservation of capital strategy. Superb work by Lowry Research, and Marty Zweig’s observation of “don’t fight the tape, and don’t fight the Fed” are contrary our stance, and must be respected. However, given the size of the potential bear market penalty, and the swift nature of how such a penalty may be applied, we want to see some more cards before being forced to dollar cost average into a larger equity allocation on episodes of weakness, if our very conservative preservation of capital stance proves to be wrong. Fortunately, ETFs make it possible to change asset allocations with the click of a mouse, and be diversified all at the same time.
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