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Rational Euphoria?: Current Sentiment Towards the S&P 500 Rhymes With This Turning Point
October 29, 2013 11:15 AM
JEFF COOPER'S MARKET ANALYSIS
A wise man once said to me, “Any fool can believe the truth. It takes a genius to believe a palpable lie.”
Often times, it takes belief in a "lie" to ride a trend that one intellectually disagrees with.
“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend and step off before it is discredited.”
It is said that the two cardinal rules of investing are these:
1) Never lose money.
2) Don’t forget rule number one.
However, the profession of speculation is unlike that of any other.
For example, a great surgeon never wants to lose a patient. He will do whatever it takes to will a patient to live.
In the markets, this can be lethal. Trying to will a losing trade back to life can be the kiss of death. Not only does it rob you of capital, it also drains emotional capital as well. Even if the situation eventually comes back, it was dead money for a period of time, which translates into lost opportunities.
We all know we are going to have losing trades and losing investments. It’s easy to get into trouble (into a trade). It’s easier to identify a promising setup than to recognize when it’s time to sell. It’s a lot harder to identify when to get out. No one wants to get a divorce when everything is going swell.
Unlike a top surgeon, we’re going to have many losers. That’s part of the cost of doing business in this game. The key is managing a position. That makes all the difference.
So, back to the wise man’s quote above. A fool believes that the vast majority of all setups he enters are winners -- otherwise, why enter? A "genius" believes the palpable lie, that the majority of setups may be losers, but he is willing to step into them with the mainstay of risk management at his back. You can take many small loses if the winning trades are meaningful.
“I am only rich because I know when I’m wrong.”
The wise man’s quote also applies to the overall market. On the heels of persistently strongly-trending markets, it is self-evident to virtually all market participants that every decline is a buying opportunity, with the belief buttressed as each pullback gets shallower and shallower. Any fool can believe the trend is not only up at this stage of the cycle, but that the trend is going to continue to creep higher for some time to come.
That’s where I think we are at this stage of the cycle. It takes a "genius" at this stage of the cycle to believe that either:
1) The market is going to melt-up with the heretofore "lie" of the great rotation (out of bonds and into stocks) manifesting into a great blow-off…
2) The market is making a major top right around this time frame despite the "lie" of the recent "breakout."
I’m certain that you’ve all been at a point in your life when you felt on top of the world and everything seemed to be going great only for that point to define a time when a difficult period emerged.
Like life, so too the market, which presents "markers" from which we look back in hindsight with the realization that things felt as good as they get (or as bad as they get) causing us to make decisions based on emotion rather than what would serve our best interests.
Never confuse your position with your best interest.
Yesterday, I saw a poll from Birinyi Associates of the Web’s most prominent investment bloggers, asking “What is your outlook on the
(INDEXSP:.INX) for the next 30 days?” The result was reminescent of another point in the market. The bulls are at 59%, the highest since
) was at 700, before it began its ride to below 400 (with the S&P pulling back nearly 10%). The bears are at 18%, the lowest since the August highs.
This type of sentiment, along with the non-confirmation between the
Dow Jones Industrial Average
) and the
(INDEXDJX:DJT) going into the October 31 fiscal year end for many of the largest funds and our early November potential turning point (not to mention the 60-month cycle looming large from the November 2008 low), means caution is warranted.
At the very least, the normal expectation, even in the bull case, would seem to be that a pullback to test prior swing highs at around S&P 1729 is in order.
Yesterday, I heard a money manager on TV say that it is lethal to fight the Fed here. That it is a given that tapering is on hold. He went on to say that as much as he might like a deep selloff so that he could take advantage of lower prices, it just isn’t going to happen because of the Fed.
I think this is emblematic of the vast majority of money managers' thinking. Just weeks ago, it was a given that tapering would begin.
I also don’t understand how this individual reconciles his desire for a deep selloff with his obvious bullish book. Perhaps he is rationalizing his position?
Over the weekend, the hair on the back of my neck went up when I listened to an interview with Alan Greenspan. When asked if he thought continued rising stock prices made sense in wake of the Fed’s programs, he responded, smiling wryly, with an unequivocal, “Yes.” This is the same Alan Greenspan who characterized the market strength with the phrase "irrational exuberance" in December 1996 from which point the market virtually doubled in the next 3 years.
“…Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”
-Alan Greenspan, December 5, 1996
The phrase “irrational exuberance” was interpreted as a warning that the market might be overvalued.
I suppose what we have now is rational euphoria.
Arguably, the current, supposedly low-inflation environment is viewed through the lens of historically low interest rates courtesy of a Fed that has scalped any bond vigilante that dared to weigh in against the Bernanke 800-pound gorilla.
So, the question is that if the market is riding the coat tails of perceived low inflation, as Greenspan once suggested, is it possible the Fed could surprise by acknowledging the pace of stock gains expressing concern over speculation rather than repeat the episode of exuberance in 1999 and 2000?
There are sufficient reasons to suspect that we’ve seen a false breakout on the S&P above 1729-1739. However, as you know, there are also reasons to be concerned about shorting the market here -- reasons that we’ve walked through
in recent reports
. To recap, there is the master cycle of 60-years, which points to a continuation of the advance through 2014 and into 2015. There is also the notion of the “fourth time through” the upper rail of a 3-point channel carved out in 2013 on several of the major indices that suggests higher prices.
SPDR S&P Homebuilders
), the key housing index, exemplifies the conundrum.
Weekly XHB Chart:
The Homebuilders index peaked in late May, and since that time, it has carved out a wide and loose pennant formation -- an indecision pattern.
Note the “dueling tails”: a Topping Tail at point A and a Bottoming Tail at point B. Whichever way the housing recovery goes, which was the culprit in the crisis, should be a tell as to determining the position of the major indices.
The S&P closed at another new record high
. If this is what record highs look like, a correction is going to be downright ugly. My screen
was heavy, littered with glamours kicked to the curb and momentum names taking it on the chin despite the uptick in the indices.
Is it possible that S&P programs were being used to mask selling under the surface as the market approaches an important month end and that the longs in many glamours were cutting and running and locking in profits?
) is a good example of heavy profit taking in the momentum names over the last few sessions.
, Vipshop left a Hook, Line, & Sinker sell setup.
, Vipshop turned up from a Plus-One/Minus-Two buy position, leaving a 180 buy signal, hooking higher on Friday’s open only to give up the ghost, skidding to a close below its 20-day moving average. In so doing, VIPS failed at its 20 DMA, which has been supportive since July, leaving a failed Holy Grail buy -- a "Grail Fail," so to speak.
Daily VIPS Chart:
In addition, Vipshop left a large-range, outside down day
(LROD or Lightning Rod). I should have used it as a short trading idea for the weekend report.
Yesterday, Vipshop popped up on the open and accelerated after triggering a down ORB (Opening Range Break). Notable is the opening pop-up that backtested the 20 DMA from the get-go, shedding 8 points in the ensuing two hours. A short at or near the early backtest of the 20 DMA provided a good risk-to-reward short-side entry. If one waited for the ORB to be triggered, the strategy was worth 5 points.
VIPS 10-min Chart:
While I missed the play, I wanted to walk through it because it is a good example of how to capitalize on Hit & Run strategies. Now Vipshop has broken the short-term trend, the vertical phase from late August that saw a near 100% advance. So, this pullback from the "100% Rule" is not unwarranted. At the same time, Vipshop is testing the 1-2-3 Pullback low from October 9. It may be oversold enough in the short term to bounce, but the 66 level represents short-term resistance. If the stock falters again in the short run, it could indicate a test of the 50 DMA around 56.
Form Reading Section:
JinkoSolar Holding Co. (
No positions in stocks mentioned.
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