THE BOTTOM LINE
The price may still be able to mount an assault on new all-time highs. However, the negative divergences in a series of supply and demand indicators imply evidence of re-surging demand over supply will likely be required before the price can achieve new highs. In the absence of evidence of re-surging demand, and given the extremes recently registered in a number of metrics, any weakening in demand over supply, accompanied by consecutive closes below first 3200, and then 3000 in short order, implies the probability of an acceleration lower may rise dramatically. If an acceleration lower does develop, then the probability of gap down openings from the previous day’s close will also increase. A change in direction toward these conditions would imply an environment of potentially escalating and unacceptable risks for our clients, especially if those changes were happening concurrently with reversals in the bonds, currencies and the precious metals, something which would be quite extraordinary, and perhaps additional evidence of “a change at multiple degrees of trend” in the equity market.
On the contrary, failure to breach on a closing basis 3200, and then 3000, would suggest a renewed assault on all-time highs. We may not know which outcome will prevail until after the results of the election are certified. The pendulum appears to have reached an extreme from which it may be poised to change direction, but when?
All these years later, I can still hear in my mind the voice of my eighth grade Civics and American History teacher, Helen Fortney, as she compared the democratic process to a pendulum, which was slowly swinging from one extreme to another. The political theory was those in power tended to apply their viewpoint until an extreme was inevitably reached, and at which point citizens would exercise their power of the vote to change the political balance in the opposite direction. Helen Fortney taught that our system of government was a self-correcting system oscillating between extremes in competing political viewpoints, and philosophies. And this implied that change happened most rapidly after an extreme had been reached, and the political “pendulum” was reversing in the opposite direction. However, given the vagaries of the political process, knowing how long the pendulum may linger at an extreme before it reverses is almost always a significant challenge for analysts to determine.
Democracy and the financial markets have much in common, as markets in theory are self-correcting like a pendulum swinging between periods of extremes in premiums and discounts to value. The worst country lawyer in the poorest county in this country could easily make the case that both the political process, and the financial markets, have approached extremes not often experienced in our history, which implies the potential for an increase in volatility in both arenas. Normally these kinds of phenomenon happen at a glacial rate of change, but with pieces of the Artic and Antarctic ice caps the size of Delaware breaking off and drifting out to sea, perhaps “glacial” rate of change is not an appropriate comparison any more.
For weeks now it has appeared that the stock market was poised to finally answer the question of whether its pendulum had reached an untenable extreme, which would result in at least in a meaningful correction to inflated premiums to value for stocks, or even perhaps a bear market on a scale (degree) to balance the long journey higher after the sixteen year correction in stocks ended in August 1982, and the initial leg up in a new multi-decade bull market blasted off, and I do mean blasted off with incredible positive metrics at the time.
Any significant top represents a difficult challenge to diagnose for an analyst, so one can imagine the challenge of recognizing a topping process as it is happening, which may lead to a bear market equal to, or greater than, the degree of the great bull run from the 1982 bottom. However, I have colleagues in this business, which can make you a compelling case that a multi-decade change in the direction of the pendulum for the financial markets is happening, as this is being written. Specifically, in the equity, bond, currency, and precious metals markets. I concentrate on the equity market, Alexander on both bonds and equities, and we pay attention to currencies and the precious metals, but we do not trade currencies and precious metals, except by client request.
The September 2-3 all-time high in stocks was accompanied by almost all the “whistles and bells” warnings a professional investor could want, and the current rebound rally has failed twice to best that high. The bounce so far has reached a fifty percent retracement in the S&P-500, a common retracement level for bear rallies. Several market metrics were so extreme at the September 2-3 top, that they may not be able to duplicate any time soon, even if the stock market mounts another assault on new all-time highs. The best we can do with these blunt tools is to say the market has likely ventured into the neighborhood of a significant top, but is yet to find the address of the house in the neighborhood it trying to locate. Key support to tilt the odds toward the bear case remains a breach of S&P-500 3200 on a close, followed in relatively short order by a decline below 3000 on a closing basis. However, the decline this past week could not even breach 3300, which continues to imply perhaps the rally may still mount another assault on new all-time highs. One last observation, it may be just a coincidence, but the Great Bull market of “The Roaring Twenties” peaked on September 3, 1929; another period of extreme and excess described in prolific detail in F. Scott Fitzgerald’s “The Great Gadsby”.
At this point another assault on new all-time highs still cannot be ruled out, but as long as steeply negative divergences (down sloping magenta lines on the attached charts) continue to exist in a series of both strategic and tactical indicators, the risks of a potential major topping process being under construction will remain.
TATY — A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown above in Snapshot-375 in yellow with the S&P-500 overlaid in red and blue candle chart format. TATY finished the week at 124 down from last week’s close, and with the negative divergence with the price still in place. Also, the premium/discount to value indicator in the lower TATY panel is below the zero line, and also has a negative divergence in place. These conditions continue to imply that the rally in the price is not being sustained with a strong and increasing balance in demand over supply.
In a normal “Big Chill” warning, TATY stalls out in the red zone after an excursion into the caution zone surrounding the 115-125 level to chill the euphoria, as the price goes on to touch new highs. Perhaps this recent one off “Big Freeze” warning will not be complete until, in like manner, as the “Big Chill” warning TATY stalls out in the red zone? Given that this is the only incidence of this situation in more than three decades, there is no historical reference. However, a new all-time high in the price coincident with TATY stalling out in the red zone would seem to affirm what we already know from Paul Desmond’s work on how significant tops form in the equity market. In this case, it would carry the additional implication that something at a very large degree, or extreme, may be afoot. And, negative interest rates, as discussed last week, would seem to confirm that “a change at multiple degrees of trend” may be in an early phase of development.
SAMMY — A REPRESENTATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS
SAMMY is shown above in daily format (screenshot 1) and below in weekly format (screenshot 2) in yellow with the S&P-500 shown in red and blue candle chart format.
Screenshot-1 shows the down sloping magenta dashed line, which was a significant warning not to follow the stampeding crowd into the euphoric, and grossly overvalued September 2-3 top in the S&P-500. Careful inspection of the chart also shows a much smaller developing negative divergence, which is associated with the current second attempt to rally above the 50% retracement level (not shown). This divergence is very minor at the moment, but if it remains on any further rally attempt, then it may become more important to the analysis.
Screenshot-2, in weekly format, clearly shows the results of the changing processes at work as the recent top(s) formed, and the weakness according to the indicators in the balance of supply and demand powering the price. The SAMMY tactical indicator is shown in yellow, and the S&P-500 is overlaid in red and blue candle format.
The down sloping solid magenta line shows how the balance of demand over supply faded prior to the price high in February, which was followed by the quickest decline to twenty percent down in stock market history. The dashed magenta line shows the paucity of demand over supply as the post March 23 recovery rally managed to touch new all-time highs. This yawning negative divergence remains in place and suggests not all is well with the rally in the price. And, as long as this divergence is not being reversed, then the stock market will remain at risks of volatility due to the magnification of the impact from currently unforeseen external developments. The sheer size of this negative divergence also implies that something on a very large scale is likely underway, which is not yet on the radar of most investors.
Lastly, the upsloping aqua colored line shows the continuing rally attempt, and the fading balance of demand over supply powering it, represented by the down sloping aqua line. This is the minor negative divergence discussed in the TATY section, but also clearly shows up in this tactical indicator as well. Negative divergences work somewhat like the rockets departing from the nearby Kennedy Space Center. As long as the rocket engine is developing power, the rocket is likely to accelerate higher. However, once the engine is throttled back, or shuts down, then the rocket will continue higher for a while, but unless the power is restored at some point gravity will cause the rocket to stall and begin to descend. Negative divergences of indicators to the price are not unlike throttling back the engine powering the price higher. The more negative the indicator’s divergence with the price, the less power behind the rally. Obviously, current conditions suggest evidence of re-surging demand must appear soon, or the rally is likely to fail below new all-time highs.