Can debt despair turn into stock market euphoria?

Wouldn’t it be amazing if somehow the House doesn’t pass their end of the legislation? Here at Lucas Wave we think this has been such a waste of time and it’s a shame it ever even came this close. If the House doesn’t pass this thing on Monday, which is the extreme lower probability, then you really have a Black Swan on your hands. So lets revisit last week’s theme.

Our view all along was that a deal would come along by Aug. 2. The smartest people in the room thought a deal would materialize. Oddly enough, the most intelligent comment I heard in the past three days was uttered by Ron Paul who stated he believes the US would eventually default because this debt problem we had was not sustainable. He didn’t think we’d default this time. If its true that 40 cents of every dollar spent is borrowed money then I have to say the guy has a point. Just so you know, I’m not a Tea Party person. I’m your non-political social observer who believes in reason.

But here’s the problem that I have along with all of the smartest people in the room. The human mind does not do well at conceiving the unconceivable. Thus we had to have the Black Swan discussion. As you saw, the markets got hit pretty good last week. What was most concerning was the broadening impact of tech beyond Apple and Microsoft. I’ve got news for you, I don’t think a little debt reduction is going to change that. This latest rally started because of tech leaders, broadened to the SOX and even got the banking index involved. So much so that the banks almost had a three-soldiers breakout. In case you don’t know, that’s three big candles to start a move. Those candles are good but not great. Those of you who really know candles will realize that the three soldiers breakout is rare. What is even more rare? To see the condition materialize and then see it negated so quickly. But that’s exactly what you have on the banking chart.

So of course we would have seen the big reaction and here’s my concern about it. I don’t hear a single outpost talking about this. Last week, it appeared we could be setting up for an inversion of the 610 trading day cycle to the March 2009 Haines Bottom. That window kicks in at the end of this week. But now that’s not very likely. Did we invert four days early? You can’t rule that out either. By the end of the week, I have to tell you that sentiment got really thick again. There wasn’t an earthquake or tsunami but I remarked to my client base that we started getting that ‘end of world’ feel to things. It seemed like we were having a smaller version of 2008 all over again. By the way, that kind of psychology is good enough to bottom out a market.

However, now relief is in the air and if House doesn’t pull a last minute surprise we should have a deal by Monday night or Tuesday. But the question I pose is how quickly will all of this despair turn into euphoria? That’s the number one factor I will be watching this week. I am going to be watching because there has always been and now can’t be ruled out a chance we could have a market top as a result of all this on day 610. The concern comes about not only because of the cycle work but as a result of a narrowing advance in tech. Folks, tech looks better than the SPX the past few days largely as a result of leadership names like Apple. Did you biotech? Its horrendous! Without the SOX names getting organized and taking off its going to be really hard for tech to sustain. Markets do top when leadership narrows. In the stock market, we need to see the rank and file participate.

Another factor in all of this is the Greenback which suddenly is doing wonders for the Yen. The big winner might be Japan simply because we’ve been so close to taking out support and the Yen has been so close to taking out resistance. The powers that be in Japan do not want to see the Yen go to new highs. With the Dollar index near support on its own, it didn’t quite set the double bottom or even new bottom I’ve been looking for but if the Dollar could sustain , we are at the conclusion of the 121 month square out and if the Dollar rallies, this time it might be real.

For a moment, also think about psychology for the Greenback. Think about the power and might of the United States. Its really incredible, what the US is capable of. Lately, due to a lack of great leadership our image has been tarnished. People all around the world look to US leadership in just about everything. Lately, it really has been tough to be proud of Uncle Sam. But the US came through and I can’t say that would spark a major move in the Greenback. But it could be enough to spark a trading leg. But we need to watch out for Dollar euphoria. The bottom line in our cycle work is the Dollar didn’t come out of July clean enough to really think about a bottom. Around the world, concern for the US went much deeper than just a dislike for the Greenback.

Why are we spending so much time coverning market psychology? It really does drive the bus and it will take a couple of days at least for the dust to settle. We did have the kind of sentiment that could end a correction at the end of last week. But this is a strange market and we need to see if we can go from extreme despair to happiness in the space of a week.

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