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When Fighting Chaos, Intuition Beats Algorithms


How a Skyfall situation is playing out in today's markets.

In my opinion, the violent price action is not just indicating whether or not the fiscal cliff is getting resolved. That's just the excuse. I think the price action is indicative of a market that is trying to turn and shake off the weak hands (in poker terms) that would be typical of a change in trend. In fact, I think investors who are focused on whether the fiscal cliff passes are making a very big mistake. I'm not saying you won't see a move off the news; I'm just saying it's likely to be a wiggle in the big picture.

The confirmation bias is overwhelmingly bullish, suggesting to me that if the move is up, it should be faded. The short-term trend may be higher, but the long-term trend is sideways; that suggests we are still in a bear market. The move from 2009 does not look impulsive in nature. When putting all the pieces together, it looks like the perfect ending to a corrective pattern whether the fiscal cliff gets resolved or not.

Analogs aren't just about charts that look the same; due to fractals, you will always be able to pick different time frames in history and line up similar patterns. For the set-up to be complete, the analog must also contain similar patterns in positioning, sentiment, and a catalyst.

I would venture to say that positioning, sentiment, and the catalyst are much more similar to July 2011 today than they were in July. The shorts have covered and are now long. Sentiment is bullish predicated on the assumption a deal will get done, which screams confirmation bias. And ironically, the passing of the Budge Control Act of 2011, which is the catalyst that blew up the 2011 QE reflation correlation trade due to the S&P downgrade, set up today's catalyst of the fiscal cliff showdown.

In fact, if you look at the 2011 move off the July top, you had an 8% orderly leg lower and then a violent rally that almost retraced the entire move and got everyone thinking of a QE III breakout. From the September top off the QE III fade, the market sold off 8% in an orderly move. Now we are in a violent rally looking to break out on a fiscal cliff resolution. Suspiciously, though, unlike in July, I can't seem to find any 2011 analogs.

Whether we rally to a new high on a fiscal cliff resolution is irrelevant. As I stated in How QE Is Impeding the Economic Recovery, I think we are in the late innings of this cycle and the stars are aligning for another leg lower in a larger secular bear market.
It is my belief that an ensuing bear leg in stocks will be very difficult to navigate from either side. I think there is a distinct possibility we just completed a cyclical bullish pattern off the 2009 low and that a retrace is in order that could take the S&P 500 back to the large 1160 pivot at a minimum with the potential for a deeper move that challenges 1000. However, unlike the two previous corrections in 2010 and 2011, this will likely not be swift and steep, but rather long and choppy.

Like Europe, the debt ceiling, and the election before it, the fiscal cliff is another catalyst used to clear out the weak hands who continue to try and outsmart the bear market.

During the tranquility of a bull market, the models work and technology can be a valuable tool to maximize returns. However, in the chaos of a bear market, the old rules do not apply and the only thing that matters is experience and intuition. My experience is telling me this is no time to be a hero by trading what everyone already knows, and my intuition is telling me this bear market cycle has another leg lower and it's time to get defensive and liquid.

Twitter: @exantefactor
No positions in stocks mentioned.
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