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Markets In for a Bumpy Ride to a Bottom


Most analysts today have never traded through a secular bear.


Editor's Note: The following is a free edition of Jeff Cooper's Daily Market Report. For a 2-week trial FREE trial, click here.

I had a dream. Crazy dream.
Anything I wanted to know, any place I needed to go.
-The Song Remains the Same (Led Zeppelin)

"This very fact that crowds possess in common ordinary qualities explains why they can never accomplish acts demanding a high degree of intelligence."
--Gustav LeBon

"All economic movements, by their very nature, are motivated by crowd psychology. Graph and business ratio are, of course, indispensable in our groping efforts to find dependable rules to guide us in our present world of alarms. Yet I never see a brilliant economic thesis expounding, as though they were geometrical theorems, the mathematics of price movements, that I do not recall Schiller's dictum: 'Anyone taken as an individual, is tolerably sensible and reasonable---as a member of a crowd, he at once becomes a blockhead.' Without due recognition of crowd-thinking (which often seems crowd-madness) our theories of economics leave much to be desired." --Bernard Baruch

"Just because it's not fundamentally sound, doesn't mean it's not happening." --Rick Santelli

If the stock market is a manifestation of crowd psychology, it leads a life of its own -- it has a mind of its own with its own internal clock. If the intelligence of the crowd is not the average intelligence of the individual, the behavior of the market sinks to a level which is separate from and below the intelligence of individuals.

A crowd does not think or reason, it reacts emotionally. To read the mind of the market, we must listen to the music of the market's mood.

The changing feelings and sentiments of investors drive the fundamentals, not the other way around.

The current conviction running rampant is that kick-starting the animal spirits is the appropriate abracadabra because the full faith in the government and the belief that the market always came back has always worked -- eventually.

The problem is, eventually is a long time. The problem is that what was once the full faith and credit of the US and the dollar has been pared back to the full faith part of the banner: credit has become contingent on the kindness of strangers. Despite the aggressive rally since March, the idea that the market always comes back has been severely tarnished. The idea that the government always saves the day and is the solution is still alive but in the fight of its life. Judging by the acrimony at recent town hall meetings and the response from the administration, the new motto of the government feels like it has become "No Representation Without Taxation."

The symbiotic relationship between government and Wall Street is being bought by the financial markets -- literally. It's not just that financial markets believe in the government -- they want to believe, they have to believe. They have had little alternative since essentially both were part of the problem.

Main Street is not so sanguine. A new downturn and a failure of green shoots to magically manifest into redwoods could send a severe psychological shiver. Question: if crisis has been completely stemmed and we're on the road to recovery and the government has used all its bullets, a failure of the party line and a second dip should cause the power of the government to be questioned. Disillusionment could cause what might be a second dip in otherwise less virulent great recessions to become more pronounced. At best it could translate into a long period of bumping along the bottom. At best it could accelerate a downturn with a hope-filled V going from a W to a Y.

Few of the technical analysts on the Street today have ever traded through a secular bear market. Nor have many of their indicators. This is the first secular bear market where technical tools and indicators have been democratized to a large degree by the computer and the Internet. There's a lot of belief being placed in a lot of indicators that have not proven themselves in a secular bear market. In my experience, the thing with most technical indicators is that while they may have worked well many times, they can fail you when you need them the most -- Anthill Indicators. Moreover, most technical indicators are descriptive, not predictive. Cycles and the price patterns they trace out in their rhythmic motions speak to the mood of investors' emotions: the music of the market rises and falls, undulates and seethes with the mentality of the mob, the sentiment of the crowd. Last week the Daily Sentiment Index hit a new high of 88% bulls. The last time this level was hit was in October 2007. Why was there so much bullishness then... the crisis was over? The belief in the Fed and containment was widely embraced. The Street bought it hook, line and sinker. Literally.

The Markets

Prior to the March 9th closing low, the S&P attempted to turn up on March 4th. From the March 4th high of 724 to the March 6th intraday low of 666.79 was approximately 57 points. A similar 57 point 'octave' from the August 17th 978.50 low gives 1035.50. Monday's high was 1035.50. The S&P tailed off leaving a Lizard Sell Signal (a new 10 day high with the low and the close in the bottom 25% of the day's range).

Most stocks were a mixed bag with few retracing their range from Friday's 'breakout'. But a second down day on momentum would suggest the market is running out of gas. A break below the key 1012 and especially the 1007 level on the S&P suggests Friday was a fake-out not a breakout. Why? As you know 1012 is THREE cycles in price of 360 degrees up from the 666 low. That was the high close on August 13th. A close back below this 1012 level and especially a close that offsets Friday's entire gain suggests a false breakout.

Especially if it should occur on the important Friday weekly close. The S&P has seen two closes above this 1012 level, possibly mirroring the 3 days below the March 4th attempted turn up. If the market is carving out a high then a small decline that holds 1018 or 1012 could see one more rally up to 1044. Why?

1044 represents a 90 degree overshoot from 1012. This would allow price to move into day 180 (opposition) from the early March low. The daily swing chart shows the trend is strong but the daily swings are becoming shorter in duration. After the August 7th pivot, the S&P Daily Swing Chart turned down (August 11), turned up (August 12), turned down (August 14th), and turned up (August 19th). This kind of behavior coupled with giddy sentiment, irrespective of my shorter and longer term cycles, suggests a defensive position. When tied to the mechanics of the music of the Square of 9 Chart, it suggests caution.

Click to enlarge

The hourly chart of the S&P from the nightly report shows that the index exploded on offsetting what appeared to be a right shoulder. This is a fractal of the explosion after the S&P offset what was a possible right shoulder on the daily chart on July 15th. That breakout elicited an 18 day rally into August 7th. Approximately four hours into today's trade will be 18 hours from the breakout of the hourly head and shoulders pattern. (See the hourly chart from the nightly report again).

As the chart shows, a break below 1012 extending below what could be a bullish backtest at 1007 (point B) coincides with a break of the 50 period moving average on the hourly chart and suggests the cycles of six months from low giving August tops as shown in the charts yesterday from 1979 and 1994 (30 and 15 years ago) may have reached a crescendo.

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No positions in stocks mentioned.

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