A Black Swan is an event the goes beyond what is normally expected in a situation and extremely difficult to predict. There are only two kinds of people in the world: Those who understand how financial markets work and those who don’t. The problem right here is that those who do understand how financial markets work can’t possibly believe the outcome of this event would fall into the hands of the people who don’t know how the markets work. In other words, the inmates are running the asylum.
You see, the really smart people in this industry can’t believe the United States would actually come to a self-inflicted default in this situation. In the past two weeks, markets have climbed a wall of worry even with the belief that through a long and winding road a solution would be reached. Here we are at the edge of the cliff and unless they are totally misleading the public, they are as far from a solution as they’ve been at any time in the past seven months. Of course, I’m not going to factor in what those extremists in the opposition party have to say, the only person who has any credibility in financial affairs that I’ve seen interviewed in the past month who didn’t think a deal would be reached is Alan Greenspan.
So let’s talk about these markets. In the past week we’ve seen tech leadership take the market higher. By tech leadership, I mean stocks like AAPL, MSFT and GOOG. It started as a narrow advance and started to broaden. The SOX came out with excellent calculations at its low and took the market higher.
The broadening effect even included the banks which had their best week since last December. It was all good. But when I tell you the problem we are going to put aside the NEWS EVENT and stick strictly to the technical position and the cycles. What last week’s move did for us is get us a new high in the NDX. The other indices were lagging but close. The bottom line to the entire market is we are retesting the top. Tops are complicated and let’s just say that the smart money is disciplined to buy the low and sell the high. This potential Black Swan event would be a perfect excuse for the smart money to sell resistance. If you forget for the moment that we are looking at the top of a 2+ year rally and pretend this is just any old high you’ll understand this much better. Any top can be sold. The part that concerns me is the cyclical positioning of these charts. We are coming to day 610 off the bottom in the SPX by a week from Friday. That’s dangerous in 2 ways. First of all, if markets were to continue higher, the 610th day of any bull market can be its climax. That’s not a prediction of this market, just a generic statement for any market. The other problem is when we are so close to an important cycle point we always run the risk of an inversion. What that means is we get a LOW on day 610 as opposed to a top. In this case it would be dangerous because of the potential for an event that could be short-lived but very intense. While we would go through it, we certainly wouldn’t think about the end. So while you already know that tech closed the week near the high, this chart shows you how the banks played along and how close we are to that 610 day window.
It’s like what I just experienced. I just had periodontal surgery which is a short and intense procedure with a painful healing process. While one goes through it, you don’t feel like you’ll ever see the other side even though you know you will. Thank goodness modern medicine can prescribe something for the pain. The debate in Washington comes with no such mechanism. All we got was Tim Geithner telling us default is not an option.
So is there a saving grace here? Fortunately there is. Usually at market highs we get euphoria and there really hasn’t been much of it. In fact, it’s just the opposite and it really reminds me of what happened in February. Right now we are basically dealing with a potential triple top. In February, the selloff started the day everything hit the fan in Libya. Fear came in really quick and escalated to historic levels in March with the earthquake, tsunami and nuclear meltdown in Japan. In May markets topped on the small degree euphoria with the killing of Osama Bin Laden.
So let’s stop for a minute and remind you of the day the Internet bubble popped. Do you remember what happened? There was news over that weekend that the government would indeed pursue monopoly proceedings against Microsoft. Of course that was after a period of prolonged, intense euphoria of the Internet bubble. I’m not saying we are in a bubble right now. But I look at February and see the potential for a fear event to damage the current proceedings which is a fine looking move up lately.