Where do we go from last week's historic volatility?

The Black Swan reached its climax last Tuesday. Make no mistake about it, it was a Black Swan. As you know it’s the first time I’ve ever used the term because I believe this event was harder to predict than the 2008 event. I’m not in the bear agenda camp, but I saw that one coming from miles away. I brought this one to your attention as a high probability because of the three key information points. First, our top was in given the NDX had an excellent reading of 2.33 points per day on the pivots in both May and July. Second, the market was coming off the high and within two weeks of the 610 trading day window to the 2009 Haines bottom and finally, the psychology of the day was the tip off. The smartest guys in the room didn’t see it coming because it is hard for the human mind to comprehend the incomprehensible. So the United States didn’t default on its debt, it just showed the world that certain elements in Congress were willing to sell the good name and integrity of Uncle Sam’s credit rating for the ability to keep their jobs.

Financial markets don’t like that. Money is universal intelligence and flees from irresponsible hands. Think about it. It’s the last time I’m going to talk about it. We’ve all had enough of this sequence.

Tuesday was a day where market started off well in advance of the Fed meeting. Here we are, getting shellacked for two straight weeks. Finally, market hit the back end of 610 day window on Monday and Tuesday it starts coming off the bottom. It looked for all practical purposes like the window was validating as we’ve discussed here over the sequence. After the Fed meeting, in the blink of an eye all of the gains were gone and we were at new lows again. That’s fine, I suppose. But what differentiated THIS particular sell-off was the fact that despite all of the fear, the VIX getting above March peaks we finally reached a point where it felt the market was going to drop to the center of the earth. It was at that moment where it was most bleak and it felt like it was never going to end.

That’s when it ended. The Dow staged an incredible 600+ point rally in short order. Then Wednesday came and markets gave most of it back. Sentiment was really thick on Wednesday. I looked at the charts and most did not take out Tuesday’s low. It turned out to be your almost perfect wash and rinse scenario. I’ve had good teachers and in this case two come to mind. One would be Steve Nison and the other Joe DiNapoli and both discuss the fact that when a low is retested to the max and holds its exactly what institutional traders look for in order to dip their toes back in to see if the water is warm. In all instances with the possible exception of the BKX, the water was warm.

So markets came off the low. Now the question is what kind of top and bottom do we have in place? We know the calculations at the top are good. We also now know the 610 day window did validate. I think whatever materialized before last Tuesday is over. Once we hit that moment where all was dark was the climax of it. But there’s lots of technical damage. The banks are barely responding. As we know, we can rally as long as the banks stay neutral but in an ideal world the banks would be leading. If the banks were leading to the upside I’d come here and tell you a bottom is in place. But lots of sectors are outperforming banks which is good. Experts who follow insider buying report there was lots of that as well. That’s good too. The kind of sentiment we had at the end was comparable to most bottoms with the one exception being 2009, that’s good too. However, I’m concerned about the fact this move materialized in the middle of summer in the middle of paint drying season. In fact, there has been no paint drying season this year. I do think we are going to get it now. We are in rally mode and I think you’ll see little in the next couple of weeks. After all, it is the last two weeks of August and the kids are close to going back to school. There is the potential for all of this to pick up again in September. But you’ll recall stocks sold off into the end of August last year and the banks turned up around the beginning of September. The lesson here is we won’t necessarily have a September/October to forget.

So what’s the best way to look at this market? It’s really very simple. The March low was support right up to last week. Look for that line in the sand to be tested. It’s already testing in the NDX. But I’m looking for a retest in the SPX. What ultimately happens there could dictate the next several month’s worth of action. If the market is going to fail and confirm a long term top, look for the former big support to become long term resistance.

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