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Janet Yellen Aftermath and the Root of Bear 'Hope'


In the new Fed-driven market environment, historically consistent trading patterns may not offer the same benefit that they once did.

This article was originally posted on the Buzz & Banter where subscribers can follow over 30 professional traders as they share their ideas in real time. Want access to the Buzz plus unlimited market commentary? Click here to learn more about MVPRO.

I never pulled the trigger on that potential Janet Yellen short-side setup that I posted on the Buzz & Banter on Monday (subscription required) because the market did not ramp into the resistance zone that I laid out. Obviously, I am glad that I did not enter the trade. Yellen did nothing to establish inflation fighting credentials as I thought she might be inclined to do. Having said that, she also did nothing to signal a more dovish Fed. In sum, the Yellen testimony was a non-event, and the market seemed to decompress from that.

The fact that the market rallied on such a non-event is somewhat telling, I believe. I think it is reflective of the fact that far too many people have been "hoping" for a 10%-15% correction. I have been fighting mightily against this tendency myself. What sort of hope am I talking about? The "hope" in this case is not a simple matter of greed or a desire to buy stocks at cheaper prices; it is it is akin to a "longing" for a "comfort zone" that matches our past experiences - at least for those of us that have been trading and investing for many years.

I think that much of what technical analysis has taught us through training and experience, is currently working against us. Technical analysis is all about mean-reversion and cycles. It's about ebbs and flows in the demand for securities. Cyclical fluctuations in prices that reflect this ebb and flow of the demand for stocks is the "normal" state of affairs in markets and is a product of human psychology. That is why we see repeating patterns in the charts. But QE has dramatically changed the environment because it has introduced a new source of demand that historically has not been there. Therefore, technical analysis -- which is based on the presumed repetition of past trends with regard to the ebb and flow of the demand for stocks -- is sending us false signals. Technical analysis is causing us to expect pull-backs and corrections that never materialize because a new source of demand (QE) is there to buy each dip before supports are tested and/or before the market completes a "measured" decline.

Please note that QE is alive and well, and it is crucial to understand that it's impact on asset prices is going to last for a long after the taper is over and QE has ceased. The excess liquidity in the economy will not go away with the end of QE. That excess liquidity is here to stay for a very long time.

Therefore I believe that as traders and investors, our historically honed instincts notwithstanding, our bias needs to remain strongly to the upside for the next few months and even years. Expecting history to "rhyme" I believe is a suckers game, because QE has changed the environment in very important ways. It didn't change human nature. But it changed the sandbox in which we are all playing and in which human nature manifests itself.

Please note that I am not saying that markets cannot or will not fall. I am simply saying that a heavier "burden of proof" should be required before investing money on a bear hypotheses. With QE, the market is a "stacked deck" against bearish scenarios and our trading and investment needs to adjust for this fact.
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