Last week the market got over the hump, with the S&P 500 closing well over the crucial 1000 level, at 1008. This qualifies as a strong statement that the underlying bullish forces remain in control.
I've been bearish, and at least at the moment, wrong about the market. Even though sentiment is strung out to the bullish side, it just won't crack. What can I say? That happens once in a while. The crowd gets to have its fun sometimes too. Of course the market will crack, as the macro headwinds are all-but-insurmountable in the long-term. We'll get into this macro view over the next few days, and hopefully I'll even make some sense on this subject.
But first, how high can this rally really go? If the remaining bears are still back on their heels -- and they are, remarkably! -- then the SPX has a shot at 1040. That's the monthly "breakdown" point from the last vicious bear market wipeout, and the market likes to meander back and revisit these breakdown levels. Obviously I thought it wouldn't make it that far, and would stop at the weekly breakdown level around SPX 1000 (plus or minus), but now the odds are shifting towards this higher target.
Today is the crucial day. The market's have to hold on to what looks like an early morning gap to the upside, based on good action in Europe and Japan over our long weekend. If the SPX can bang up through 1015 -- and hold there -- then we'll be looking at SPX 1040. I won't hang onto any bearish positions through that, and my ill-fated half position in the Rydex Tempest Fund (RYTPX) will be stopped out. (I'll send out an intraday update to subscribers if action is needed on this). So although it's not over yet, my 2+ year hitting streak with these Rydex positions without a loss may be coming to an end. It would be entirely in keeping for a vicious bear market to coldly stop out every last bear before taking the big plunge.
But I'm not going to change my methodology, just because of this one position. We've generated cumulative gains of 250% throughout the bear market, doing a very, very simple thing. That is, I've simply tried to take the opposite side of the "herd" for every major sentiment swing. When everybody is bullish, go short. When everybody is bearish, go long. It's simple, and it works great in a bear market. Since we're still faced with a long-term secular bear market (more coming on this) we're not going to want to change tacks just yet.
Now, during a bull market, the strategy is even easier: you buy the dips.... and hold on, hold on, and then hold on some more. But we're just not entering that kind of multi-year bullish market environment. In fact, we're coming off the best 18-year period that the world has ever seen for that buy-the-dips-and-hold-on strategy. That's a primary reason why the bear market strategy of playing the sentiment swings should work now for a long, long time -- in spite of this current aberrant pratfall for contrarianism.
To illuminate this further, I need to make some important points about bull markets and bear markets. To make these points, I'm going to rely on the work of Michael Alexander, a wicked smart researcher who wrote a fantastic book called Stock Cycles right before the markets peaked in 2000. I'm so impressed with the thoroughness of Michael's research into the fundamental underpinnings of market cycles and market history that we're actually publishing his next book -- which is almost ready to go -- and I'll be introducing you to more and more of his work over the coming weeks and months. I guarantee you'll be impressed and illuminated.
Most people would be very surprised to learn that from 1966 to 1982 -- a 16-year period where the market stagnated and went nowhere -- corporate earnings growth was equivalent to the earnings growth during the great bull market from 1982 to 2000. So here's the pivotal question, which Michael Alexander addresses: "Why did almost identical earnings growth produce a 1000% rise in the index during 1982 to 1999, and no rise from 1965 to 1982?"
The answer is the monetary environment was different. The stagnant period was characterized by rampant inflation. The booming bull market saw inflation contracting sharply. In Michael's words: "Inflation has a dramatic impact on stock performance because it dramatically impacts the perceived value of a certain amount of earnings."
In other words, the market was able to achieve such a high P/E ratio during the bull market because inflation had been tamed, and the market was giving a higher value to future earnings streams because of this low inflation environment. It was a tectonic shift in sentiment that took place over many years, extrapolating high-growth and low inflation off into the distant horizon. Naturally, futures earnings streams became worth much more.
But now, the opposite effect is set to occur. For reasons we'll go over tomorrow -- but you know most of them already, including soaring budget deficits and ballooning debt of all kinds -- inflation is getting set to make a rip-roaring comeback. The stealth bull market in gold and commodities over the last few years is also confirming that the tectonic plates are shifting back towards a multi-year period of rising inflation.
The upshot is in a period of rising inflation, the market starts to give less and less respect to the value of future earnings streams, which leads to vicious and insidious multiple contraction as P/E ratios come down relentlessly. Companies can look to be doing pretty well from a business standpoint, but their stocks get hammered anyway as the value of their future earnings is losing its desirability, because of overall rising inflation. This is what happens in secular bear markets, and as Michael Alexander shows, the principal cause of these stock cycles is inflation and the monetary environment.
I'm running out of time and room now, but we'll pick up this discussion again tomorrow, because it's really "the whole ballgame" in terms of investment strategies for the coming years.
Sentiment Dashboard
by Adam Oliensis
SENTIMENT TANK: Remained unchanged at 8% full of negative sentiment. While the VIX dropped the Put/Call Ratio soared to 1.29. Much of this may be due to institutional action in the QQQ options.
SHORT-TERM: In a solid advance phase.
MID-TERM: Progressed from a neutral 81/19 condition to a sell signal at 23% on the decline side. Has crossed below the key level of 80 (sell) but has not crossed its trigger line (down 4% from here). Confidence is telling a complex story by remaining at a bullish 1. Why? Because, with the VIX locked in a low range with very little momentum this gauge is flopping around measuring TIME more than anything else. The WINDOW OF OPPORTUNITY for a decline phase is now. If it doesn't assert itself strongly in the PRICE ACTION very quickly, that window will close and that will have intermediate-term bullish implications.
LONG-TERM: Weekly gauge progressed to 9% on the decline side but also has a bullish 1 in the Confidence window. This gauge has been trying to give a bona-fide sell signal for some weeks and failing each time. This COULD be the one...but we'll have to see that green "1" flip strongly to the red side.
BOTTOM LINE: The sentiment indices continue to be ripe to turn red (sell). If they can't muster a real spark of fear in the market's complacent heart, then the bulls will be further emboldened. I continue to believe that the key level to watch is the 1015-1021 level on the SPX. A price break over that area could set off a climactic buying spree. Failure at that area and we may see a genuine spike in the tank level that could set off a trip back to the SPX 960 area.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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