(The following is the Introduction to the latest BullBear Market Report for BullBear Traders members)
In the last BullBear Market Report, I called for a significant correction to begin and announced that I had closed all long positions and initiated a short position. My current analysis suggests that that continues to be the correct view of the market, but that the topping process is still in progress and that substantial downside may yet be a few weeks away. I'm back to 100% cash and awaiting a good shorting opportunity. I've changed my market stance from Bullish on all time frames to long and intermediate term Neutral and short term Bullish.
It's important for readers to note that I am not a permabear. In fact just a month ago I was 100% long and firmly bullish in my outlook. But I think it's crucial for traders to practice non-attachment to views. Rigid self identification as "Bullish" or "Bearish" is a major hindrance for any market participant. It's important to be able to let go of an established view when the market reality changes. Zen master Thich Nhat Hanh says:
That doesn't mean we should throw out an established view casually either. But views should be constantly tested and probed for weaknesses using objective criteria and analysis. During solid market trends, such probing finds confirmation of the view. But during the process of a market trend change, eventually probing reveals weaknesses and soft spots which over time develop into a reversal. It's very possible we are already well into that process now and that a trend change is looming.
Markets are fundamentally driven by the dynamic between buyers and sellers, supply and demand. That includes the capital markets. So ultimately it is a game based on liquidity. Whether liquidity flows into a market depends upon the available pool of capital as well as the psychological willingness of participants to risk that capital in the given market. When the pool has run low and most participants are already in the pool, the trade is crowded and it will inevitably reverse. The extent and duration of the reversal depends on depth of the imbalance. Eventually the pool will become relatively full and will look enticing and market participants will start to dip their toes in the water once again, eventually climbing back in for a swim.
When I analyze a market, my process proceeds from the What and then to the When and lastly the Why of that particular market. What is the market doing, when is it going to do it and then finally why is it doing what it's doing. I first concern myself with What a market is doing: is there an identifiable trend or is there a topping or bottoming process? Then I focus on When: is the market likely to continue its trend for a given time frame or is due to reverse or consolidate sideways? In the process of doing what it is doing when it does it, the market eventually reveals why it is doing it. As that process is unfolding I try to identify the motive forces for the move to evaluate its durability and potential extent.
When I turned bullish in March of 2009 and again in September 2010, I put forward a set of criteria that could both explain the apparent bull market and potentially underly its perpetuation. Evaluating these criteria now I find that they are, at this time, unverified by market action. This, together with the technical action of the markets at their current state of development, forces a reevaluation of my market position.
My set of criteria for a continued bull market at this stage of the game:
- Emergence of a leading economic growth sector, most likely Green/Clean Technology and other Tech
- Leadership from BRIC and Emerging Market sectors
- Re-initiation of currency carry trades, most likely Yen carry trade
- Flight of capital from low yielding bonds to risk assets
- Eventual, gradual broadening of participation in the bull market from professionals and institutions to the general investor population and eventually the general public.
- Technical condition of the market remains healthy
At this time I am not seeing any of these criteria being met. Recently, most of the above were approaching or exceeding levels in keeping with a bullish view or were at least showing signs of moving in a bullish direction. But all have effectively reversed or aborted at this point. In this report I will detail and evidence this with research and analysis. Here's a brief synopsis of my findings:
1. NO LEADING GROWTH SECTOR
If stocks are in the third wave of a bull market, at this stage we should expect to see certain effects in the underlying economic fundamentals that confirm that price action. One of the criteria I was watching for was a Green/Clean Technology investment boom. Any sustainable economic recovery and concomitant bull market in stocks would require a leading growth sector. That sector should add value to the economy, increase productivity, produce real job growth and stimulate activity across the rest of the economy while also providing leadership in the general stocks bull market. The Housing industry and associated stocks served this role in the 2003-2007 bull run. This time around, we were promised by government and Wall Street that the road to economic renewal would be paved by Green investment. So far there are no signs of a broad based move by the private and public sectors to invest in such technologies and infrastructure. The ETFs that track Green investments have recently broken down after repeatedly threatening to break out, indicating that a stock investment boom in Green Tech is not happening at this time. Absent a leading growth sector, the move off the March 2009 low then becomes a purely liquidity driven rally.
2. NO LEADERSHIP FROM EMERGING MARKETS AND BRIC
If the US domestic market has no leading growth sector to propel the economy and stock market forward, perhaps the engine of forward progress could be found in the BRIC and Emerging Markets. I'd be willing to accept that hypothesis, but at this point rather than leading the way up, BRIC markets are actually leading the way down with many Emerging Markets following close behind.
3. NO YEN CARRY TRADE
After the Japanese Yen spiked to an all time high in the wake of the recent earthquake and tsunami and world monetary authorities initiated a coordinated intervention, many speculated that the Yen would then reverse and become the target of the carry trade once again. The Yen carry trade had been a major funding source for risk trades in prior bull phases. This hasn't really come to pass yet, and the Yen is not far off its all time highs.
4. NO BOND BEAR MARKET
In a protracted, sustained bull market in risk assets, bonds should suffer as investors leave the perceived safety of the debt markets for riskier plays. While the 30 Year Treasury and other sectors of the bond market has flirted with significant intermediate and long term levels, the Total Bond Market is back to a new all time high.
5. NO GENERAL INVESTOR PARTICIPATION
While professionals are totally committed to the bull, the general investor community remains reticent in spite of some positive stock mutual fund flows in the early 2011 time frame. The general public is still completely out of the markets. While this is theoretically bullish since that means there is still a large untapped cache of buying power on the sidelines, it may not work out that way if psychology is so damaged that non-professionals simply will not take on risk at this time and there are insufficient contingent circumstances that will force them to do so.
6. DETERIORATING TECHNICAL CONDITIONS
SPX is either well into the major 3rd wave of a bull market and in the process of an intermediate term correction or it is approaching a completed C wave top. The emerging underlying technical conditions suggest that a C wave top of the move off the March 2009 low has either been achieved or will be shortly. The first warning shot across the bow was the Commodities Crash of early May. Breadth deterioration began in February and now significant divergences between market price and breadth indicators have emerged. Sentiment has turned broadly bullish for the first time, generally a contrarian indication.
Overall, the circumstances outlined above together with a number of other factors--end of QE2, summer seasonality, waning bullish economic news, bearish news items out of Europe--combine to set the stage for a significant correction or even the resumption of the bear market. We'll have to see how the market actually performs in the weeks ahead, but I am actually leaning in the direction of calling the March 2009-Februrary 2011 move a three wave ABC bear market rally. In that context the next probable move would be a three wave partial retracement of that rally to put in a final bear market bottom.
Traders should keep in mind that topping is a process and SPX may be in the early stages. False breaks, false starts and sharp counter rallies may be common as shares are gradually distributed. I'm leaning towards a week or two of mild, grinding upside pressure with a top in the 1340-1380 zone. Then again, the market is set up such that the wrong news out of Europe could break support and initiate a cascade of selling pressure.
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