Sentiment Speaks: The Market Got It Wrong - Again?

by: Avi Gilburt

Summary

- Recent price action.

- Anecdotal and other sentiment indications.

- Price pattern sentiment indications and upcoming expectations.
 
Recent price action
 
Last week, I noted:
 
While many will now turn bullish in disbelief of the action in the equity markets, I am now finally turning somewhat cautious, and will likely remain so until the fall. My expectation is for last week’s ascent to slow down in the SPX over the coming weeks, which will likely result in a multi-month top being struck, sending us back down to the 2300 region in the SPX in the coming months.
 
And, while the market continued its ascent, we have seen more consolidations taking hold, which suggests to me that the ascent is indeed slowing.
 
Anecdotal and other sentiment indications
 
As the market continued to rally this past week, more and more investors and analysts have been scratching their heads. Unfortunately, they believe that the market is simply not justified for reaching these heights.
 
Ahhhh. But, wait a second. In their mind, the market is only as a high as it stands right now because of central banks. Yea. That must be it. At least that is the reason they have all fallen back upon because they cannot fathom any other reason for markets to reach these heights. And, if they cannot see any other reason, then clearly none must exist.
 
So, they are quite certain that the only reason markets have reached these heights is because of central banks. In fact, they clearly believe that central banks are all powerful, control all markets, and markets cannot come down again because of the central banks.
 
Now, I truly love Disney World. In fact, I am going with my family in a few weeks. And, like many others, I really appreciate Fantasyland. However, when dealing with the markets, it seems many of those who believe central banks are all powerful are perpetually living in Fantasyland, even though they reside well beyond the boundaries of Disney World.
 
I have now read a multitude of articles written on Seeking Alpha calling for the end of the bull market over the last several years. And, many note how central banks are the only reason the markets have reached their current heights. One recent article even noted that, despite all its herculean efforts, the BOJ will never be able to hit its inflation target.

Huh? Wait a second. I thought central banks are all powerful? I thought they control the markets? I thought they are the only reason the equity markets have reached these heights? Yet, how can they not hit their inflation targets?
 
Either they are all powerful and can control the markets, or they can’t? Have you ever heard of anyone being “a little pregnant?”
 
While you try to figure that one out, let me give you something else to chew on. If central banks are as powerful as these analysts claim, and they have every reason to continue to prop up the financial markets, should that not mean that we will never have a large correction again? And, is that not what Janet Yellen said not too long ago?
 
Moreover, the analysts that claim that central banks are pushing the markets higher are, oddly enough, the same ones who have been calling for a market crash for years. Does anyone else see any inconsistency or circular “logic” here? You can’t have it both ways boys.
 
And, if you really think about it, one has to question why those who are so certain regarding the power of central banks have not been suggesting investors place their money alongside those central banks for the last few years rather than cautioning about a crash every week!?
 
The reason they have not is because not even they truly believe their own rhetoric, and just use it as a convenient excuse as to why the market has acted opposite of their expectations. Yet, they continually lecture the poor fools who made money during the 700-point rally from the February 2016 low.
 
My friends, we will have a correction again. In fact, we will likely see a 20% correction beginning next year no matter what the central banks do, and likely from much higher levels. And, when we do get that correction, many of these analysts will begin to pound their chests, as their broken clocks strike that particular time of day which makes them see correct.
 
But, either the central banks are all powerful and have been pushing the market up to new all-time highs week after week or something else has. If the central banks are truly that powerful, then we will never see another 20% or more correction. And, if we do see such a correction, then clearly the central banks are not all powerful, and something else is controlling the market. To be honest, I don’t need to wait for that 20% correction to already know the answer. If one understands that correlation is not akin to causation, then you will know the answer too.

At the end of the day, anyone who believes in the omnipotence of central banks will be setting themselves up for a world of hurt several years down the road, and from a much higher stock market level. And, just as the truth of the matter is that the central banks are not controlling the market on the way up, they will be unable to prevent the market to drop on its way down. To believe otherwise is to believe that central banks can control the markets on the way up, but not on the way down. Again, a little pregnant?
 
And, for those who have not bothered to learn from history, allow me to remind you of the words of Irving Fisher in 1932, who also originally believed in the omnipotence of the central bank:
 
“The Federal Reserve System, from February to December 1931, increased the issue of Federal Reserve notes by 80%. These issues were due to bank failures which made necessary a larger use of cash. Yet, after a wave of bank failures . . . both banks and their depositors began raiding each other in a cut-throat competition which more than defeated the new issues of Federal Reserve notes.”
 
Here is one more quote for you to consider:
 
"Those who cannot remember the past are condemned to repeat it.”
George Santayana
 
Price pattern sentiment indications and upcoming expectations
 
As I have noted over the last two weeks, I am looking for the market to top out in the near term. Our longer-term target for this wave (3) off the February 2016 low begins at 2487SPX, and was as high as 2564SPX. However, based upon the smaller degree set up in place now, as long as we remain over 2450SPX, I think we will likely strike the lower end of that target region between 2487-2500SPX before wave (3) tops out. While there is a smaller probability we can push higher into the upper region of our target, for now, my expectation is that we can top out in the lower end of that target region.
 
But, as I have noted many times before, it is not likely that this bull market run off the 2009 lows has run its course. Rather, whatever top we create over the coming few weeks will likely send us down to the 2300SPX region, and set up a rally back up towards the 2611SPX region. It will be after the rally off the next pullback that the market will set up for a 15-20% correction, likely starting in 2018.

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