In recent BullBear Market Reports I was able to successfully identify the apparent Wave 3 of (3) top at SPX 1344. I advised BullBear Trading members that I was taking 40% of my long position off the table and closing long positions in Nikkei as well as exiting short US Treasuries. I might have taken more of the position off but there was some doubt, until the Japan Panic hit, about the degree of the correction at hand. All in all, the analysis and timing were quite solid.
On Thursday I went long SPX, Emerging Markets, BRIC, Nikkei, Grains and Agriculture and short US Treasuries. I also have a small speculative long position in DollarYen. I am tilting bullish on EuroDollar and bearish on USD at this time.
In this report I'll examine the current technical condition of the markets and the probabilities going forward using a range of tools including Elliott Wave analysis, Trendline and Fibonacci studies, momentum, breadth and sentiment.
A quick perusal of the blogosphere and mainstream financial media reveals that the predominant sentiment underlying the markets remains bearish. Fear remains the primary driver of market participation. Many have been quick to call a major top and few are willing to view the current decline as a buying opportunity. In fact I have not been able to find a single analysis or opinion which regards the current market setup as a buying opportunity, but a plethora which expect further bearish outcomes. Here's a piece that hit my inbox:
This quote from a recent blog posting sums up the bear argument: "With an already failing economic recovery in the US, a black swan variable such as the Japanese quake, Tsunami and nuclear crisis may very well be the tipping point that sends the entire world into a financial and economic catastrophe."
Experienced, grounded traders know that panics in an entrenched bull trend produce bottoms and buying opportunities, not catastrophic declines.
Many technical gauges of market sentiment have registered levels of fear typically associated with intermediate term corrections. The reaction to the events in the Middle East and Japan appear to have quickly catalyzed the remaining underlying bearishness into a healthy correction within a bull trend. It's impossible to say what might have been, but it's possible we would have seen a correction of a lesser degree had Japan not blown up. It really doesn't matter though, because eventually this larger degree correction would have occurred from slightly higher levels. News has simply hastened the inevitable. For those bullish on the markets, this is a fortuitous set of circumstances since it has most likely cleared the decks for a higher degree advance from here.
Assuming that the Japan nuclear debacle results in damage and risks as serious as those attending the Chernobyl disaster, would that in and of itself be enough to derail world economic growth or even the Japanese economy? This is highly unlikely and there is no credible evidence that this would be so. Markets have reacted emotionally as traders have sought to lock in profits and seek safety in the short term. Emotional reactions create opportunity.
Tape reading is an important skill for the trader to develop. It takes years of careful observation of many markets under many circumstances. One of my favorite maxims: "When a market does not do what it should do when it should do it then it is probably about to do the exact opposite in a big way". In other words, a failed setup is often more powerful than the setup itself. With all the widespread, rampant talk of catastrophic market consequences stemming from "skyrocketing crude oil prices", food riots and revolution in the Middle East and the Japan earthquake, tsunami and nuclear plant crisis, the US equities market is currently trading a mere 5.5% off the high. Three moderately strong rally days could entirely wide out this deficit. There appears to be a significant gap between the talk and the walk here.
Of course other markets have not fared so well. Japan has essentially crashed in a few short days, and is currently trading about 20% off its highs. EuroStoxx 50 is off 12.5% from its high. On the other hand, during the course of the entire Middle East/Japan panic, emerging markets have actually held position or even edged higher. Emerging Markets (NYSEARCA:EEM) and BRIC (NYSEARCA:BKF) as a group have travelled sideways since the February 18 high and select markets are in fact higher now than they were then. Other markets suchs as Canada's TSX are only marginally lower.
This is the ONLY significant POTENTIAL bearish setup I have seen since the July 2009 low. If the technical indicators were giving me cause for alarm I would be 100% in cash right now and waiting for a shorting opportunity. I will continue to monitor the technicals so that if the charts and the technicals conspire to produce a bearish setup I will be ready to take appropriate action. Next week may be the most critical week in the markets since April 2010!
Disclosure: I am long SPY, EEM, BKF, JJG, DBA.
Additional disclosure: Stops in place near recent lows.