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A Different Structure

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In late April, I was quite bearish on the broader market. Sentiment was enthusiastic, the market was overbought, and we were clearly still in a long-term downtrend. That stance proved to be incorrect and costly, as the market ignored what "should" have been and powered higher. At the time, I said that the S&P 500 needed to take four distinct steps before I would consider the "new bull market" camp the higher-odds bet. This week, the S&P completed step 4.



STEP 1: Break the downtrend line. Completed in early May.
STEP 2: Form a higher high. Completed in June.
STEP 3: Successfully re-test the breakout area. Completed in early August with a touch and reversal of 960. This step is the most questionable, since we only corrected a little over 5% from the high.
STEP 4: Break out to new highs. Completed this week.

Note that this is MY definition of what bullish action looks like, and is not necessarily what you would find elsewhere. It is what I needed to see to convince myself that the structure of the bear market had changed, and it now has in my eyes. This doesn't mean I want to go out and buy S&P futures this morning, but it does mean that as long as we hold 1015 initially, but more importantly 960 (from step #3 above), I want to concentrate on gauging oversold levels in order to buy instead of working off overbought levels to sell. In my opinion, the best risk/reward trades will now lie with buying oversold conditions. In hindsight, that would have been the way to go ever since March, but it is not how I saw it beginning in April.

We're certainly not at an oversold point now. We're overbought as I look at it (but do you know anyone who DOESN'T think we're going to pull back here?), and we've seen some rampant speculation this week, which I guess is what should be expected when the broader market breaks out to a new high. But when the dust settles, and if the market is still above support levels, it should begin to set up good risk/reward trades from the long side.

Obviously, the biggest risk here is that of a false breakout. We saw remarkably similar technical action in 1998 as the S&P rallied 20%+ into the Summer months, went through a three-month, 5% trading range, then broke out to the upside before plunging. With the current sentiment situation being somewhere between bad and horrible, I think a repeat of a 1998-style false breakout increases substantially. A break of 1015 to the downside will put me on guard and neutral, but a break of 960 should be watched more closely, as it will invalidate the constructive structure we're now seeing. I don't set price targets, so I don't know where this rally may end if indeed it does continue. Instead of specific price levels, I will be more concerned if I see all-out, pedal-to-the-metal speculation. We're seeing some of that already, but we're not yet at a point that it would have me selling new multi-month highs in the broader averages. Toddo has talked about the rally ending when the last bears throw in the towel. That's happening more and more each day the S&P makes new highs, so that's another dynamic that needs to be watched.

By the by, as an avid hunter and fisherman, and as someone who has been on well over 500 farms in my life, I have to say that I would take fresh venison over just about anything farm-raised any day of the week. Anyone who's been on a turkey farm or seen how veal is raised would probably agree with me!

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No positions in stocks mentioned.

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