A bullish day but with a weak close and weak after-hours produced a candle with a tail to the upside that could spell a reversal, with new moons often marking tops. The SP500 has rallied back up to the measured decline trend since September and has made a retest of the broken bull trend of the last 18 months, so adds to this being a suitable spot to reverse:
Additionally it has made a 61.8 fib retracement of the Sept-Oct falls, and this is in keeping with the second chance peak of 1929 which was a 61.8 fib retrace of the initial falls.
Underlying Source: Ritholz
On the flip side, Apple and Biotech broke out to new highs, so we have to allow for an alternative scenario of wider new highs being ahead, unless the markets swiftly reverse here. However, when we look at Nasdaq breadth as a whole we see a continued pattern of weakening with underperformance behind the current rally, which casts doubt on such broader new highs:
The key question is where we are in the topping process. It’s a process that began at the turn of 2014:
By the majority of indicators we are late in the topping process, equivalent to January 2008 or October 2000. So when we look at the selling climax of last week, the most applicable mirror is that from the turn of 2008, the first true leg down in the bear market:
If that isn’t our current position, then we would be looking at a catapult to higher highs. Ditto the reading in capitulative breadth that last week hit a ‘bear market bottom’ level. How do we reconcile those with (1) II bears still being at the (toppish) extreme <20%, (2) AAII bull-bear ratio back over 2 despite last week’s sell off, (3) margin debt and net investor credit still being at levels that exceed previous bull market peaks, (4) the average of 5 valuation measures putting us on a par with the 1929 peak as the second biggest mania after 2000, and (5) allocations such as Rydex and Fund Managers still being too high to have sustained a washout?
I believe we can reconcile if CBI and selling climaxes marked the bottom of the first leg down in a new bear market, because the sentiment, allocations, leverage and valuation indicators have a long way to go yet before they will have mean-reverted.
The wildcard remains the solar maximum, which I believe is the most dominant force in play. It is the reason certain indicators reached all time extremes this year and why speculation once again became of mania proportions. The stamp of previous solar maxima such as Nikkei 1989 and Nasdaq 2000 has been all over this year’s developments. Knowing that the current solar max has comparisons to SC5 which produced a delayed smoothed maximum or that the market resonates with 1929 which was a delayed peak beyond the smoothed maximum, then we have to allow for the possibility of a peak stretching out into 2015. However, this is where the cross-referencing has been powerful…
The most probable scenario by solar models and data is that the smoothed solar maximum is behind us circa March time, and we can cross-reference that with the peaks in the R2K index and margin debt, i.e. it appears speculation did indeed peak then. Generally, indicators reveal a 6-8 month topping process that ended in September, and this timeline fits with previous major peaks. Various indicators aligned already with the solar/market peak in March 2000, not earlier in the process. And through a combination of extremes in leverage, allocations, sentiment and valuations in the face of a demographic headwind, we appear to have reached saturation in the markets, i.e. questionable that there would be fuel to go some way higher yet.
In essence, if we remove the solar maximum from the equation then we have a strong case for a topping process in equities that initially began 31 Dec 2013, had an epicentre around March, and completed by September. If we now add the solar cycle back in with most models pointing to a smoothed solar max behind us around March, then this looks doubly compelling versus the chance of a market peak delayed until 2015. But, if I am to be proved correct, then equities have to now turn down again and not reach back up to new highs.
Year to date sector performance still looks like a trademark market peak. These are the two sectors that perform the best once the market tops out:
Earnings growth for Q3 currently stands at 5.5%. This needs to be over 10% to justify valuations. Don’t take my word for it: analysts projections for this quarter at the turn of 2014 were 13% growth, but the reality means they were gradually reduced to 5% as the year progressed, so now in fact we have a little ‘beat’. I just don’t believe that is enough to propel equities higher, but rather, the gap between valuations and reality has been a flag for 2 years now and with three failure quarters out of three so far in 2014 that gap is at its biggest yet. Hence I believe the repair in price is now underway and we are in a bear market.
The Sornette bubble end flag still shows as July for the SP500 and September for Technology. There has been no move back up with the recent rally.
Source: Financial Crisis Observatory
The European indices are bearish, unless the Dax can break back upwards here. Rather it appears the ideal place for a reversal back downwards, along with the US indices.
The pattern of a lower high and a lower low since June is fairly clear on the European indices and also on the Russell 2000 and the Bloomberg financial conditions index. What’s missing is a definitive lower high on US large caps, so that is what I am looking for. Uniting all the above analysis I believe this has to now occur and that we won’t rally back up to new highs. With the new moon now behind us and stocks arriving overbought and on negative divergences at suitable technical levels for a reversal I expect stocks to reverse back down to last week’s lows. Once that occurs we can judge whether there is evidence of capitulation again and also of positive divergences. I believe there won’t be and that will be the trigger for the markets to then cascade lower. But first things first, let’s see if equities are repelled from yesterday’s peak.