SPY: Traders Love This Nervous Market
Summary
- Moving from a straight up market to a step up market.
- SPY retesting support to see if it holds.
- Traders betting on a retest of the bottom.
- But strong support here at $266.7.
- A break below points to a retest of $260.
The market, as tracked by the SPY (NYSEARCA:SPY), is nervous and bouncing around to create a "trader's heaven." Traders just love inefficient markets created by a lack of liquidity and short term, emotional bad news, disconnected from fundamentals. There is no fundamental, rational reason for these big swings in the market. There are plenty of emotional reactions to perceived bad news about tariffs, rising interest rates and inflation. Those with clear, fundamentally rooted analysis, (think Warren Buffett here), always buy on weakness when the fundamentals are good. They look for emotional moves in the market, based on rumors, and forecasts of the future that are probably wrong.
Discounting Bad News
Nobody can forecast the future, but the market has to discount bad news into the future. Usually discounting bad news results in an oversold market. Then after the selloff, the inflation does not appear short term as expected, the rates do not go up as anticipated and there is no immediate reaction to the tariffs. Usually short term fundamentals continue strong and the market forgets about the long term bad news. It bounces back short term and waits for the forecasted bad news to actually hit the market. That actuality is the real end of the bull market, not when the bad news is first heard.
Traders Short Any Bad News
Traders know all of this. They short the market on the bad news. Then they go long the market when it is oversold and the market has forgotten the bad news and is now focused on some short term good news, like low inflation and no interest rate hike as expected and the positives of the tax cut.
Making Money With the Traders
So how do you make money? First you have to be convinced the market is good for 2018 and the target for the SPY is around $290 to $300. You have to look out to the end of 2018 because that is what the market is doing. What do we know about the end of the year? Yes interest rates will move higher, but they will still be historically very low and that stimulates the economy and the stock market.
Second, we know the tax cuts are playing out in a positive manner and will take corporate earnings higher and stocks higher. There is a positive attitude among investors. Last year the stock market delivered great returns and investors are looking for more of the same in 2018. That won't change until the bull market changes to a bear market and there is no sign of that.
Third there is a major change taking place in the stock market. As a long bull market approaches a top, it becomes more volatile but it takes some time for a market to top out. It gives plenty of warning signs that is happening. We don't have any of those signals yet. Maybe we will see that in 2019 or 2020, but they have not appeared yet and unlikely to do so in 2018.
Stock Market Is Not Yet Overvalued
The stock market is fairly valued to slightly overvalued. There is no sign of the extreme overvaluation that precipitates a change from bull to bear.. The boost in corporate earnings from the tax cut, diminishes the chances of an overvalued market in 2018.
Traders Switch From Short to Long
This leads us to the conclusion, that traders shorting the market now, will be quick to switch when the market bottoms for the bounce up to test the old high. We will look for our Supply Signal to bottom and turn up to catch the traders moving from shorting the market to going long.
Here is the chart showing the price action in the SPY:
When to Buy on Weakness
How will we know the market has bottomed and will bounce again? Note the negative surprise in our Demand Signal. It never moved back up to recent high Demand levels. Instead the Demand breakout aborted and turned back down into Supply. Now we have to wait for Supply to bottom and start up again heading for a Demand breakout. That will tell us the traders have switched from playing the short side to playing the long side for the bounce up. Stay tuned. We will post it when it happens.
Conclusion
Obviously, traders think they can take the SPY down to retest the $260 bottom. However, it has to break below strong support here at $267.7. I expect a bounce from this level. If it slices through without a little bounce here, the traders will be right about retesting the bottom. It looks like a self fulfilling prophecy for the traders. They are coining money and loving the new volatility. You can follow them if you want to trade. As fundamental investors, we will wait to buy on weakness, if not the exact bottom of this pullback. In bear markets we don't buy the pullbacks, but this is not a bear market, just a speed bump. Price just got ahead of itself and was overbought. It is in a transition from a straight up market, to a market with regular pullbacks to test support just like this. You have to accept the new normal in the market. It's really the old one come back.
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This article was written by
Tom’s book "Successful Stock Signals for Traders and Portfolio Managers" is available on StockCharts.com and Amazon. The StocksInDemand.com system is designed to make money using a combined fundamental and technical grade for each stock. Tom received his MBA in Accounting from St. John's University, where he taught courses on the stock market. He marketed fundamental research, technical research and quantitative research to professional portfolio managers during his Wall St. career. He uses all of these methods to pick stocks for investing and trading.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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