We looked for a muted Santa rally this year, we got it. It’s important to note that while the media considers a Santa rally to come the week of Christmas, in reality the timing of it is supposed to be the beginning of December and should last at least thru the period where traders take their year-end vacation.
This year it came in one fell swoop and we’ve been retracing it ever since. We had strong starts from biotech and steel stocks and they have mostly faded. The sector that is still working is drug stocks. Apple computer backed off which was a key consideration of why tech backed off last week.
My biggest concern of the week (which is last week’s news) really has been what the Chinese Premier said regarding they have inflation under control. The SSE voted last week and may have finally found a low. However it outright rejected the bigger 261 day window last week. My next biggest concern and as far as markets go this is the most important technical news heading into the new week. We have a VIX trading in the 20’s after the market had a couple of really tough days. That means traders are complacent with where we are in the bigger scheme of things. I understand it’s based on a lower volume holiday seasonal type trading agenda. Still, when the market trades lower and the VIX doesn’t spike you have to be concerned about it. The condition is not likely to materially change between now and the New Year so January might be more bearish. We hear on television that it’s actually a good thing as traders are anticipating less volatility. Nothing could be further from the truth. Since when do traders get what they want from the stock market? The stock market is not the take-out counter. In recent bottoms the VIX was sitting in the mid 30’s and for us to get there it would require several big distribution days and I don’t really think you can have the volume the rest of this year to accomplish it.
This is a good time to explain what fuels trouble in the market. You’ll recall earlier in the year when markets were topping how news represented the prevailing psychology. First we had the soft patch in the February to May sequence. I’m still trying to figure out what a soft patch really is. After the soft patch sequence Bob Pisani reported from a big hedge fund conference that the big players were looking at a ‘see-over’ trade. Do you remember that? Simply put, by June and into July when the NDX finally topped hedge fund managers were looking beyond the soft patch to the 4th quarter when they anticipated that GDP would be rolling again. It’s this kind of complacency that gets us in trouble. Bear markets will extend to the point the complacency is washed out of the system and fear levels rise like they did in March, August and October. That’s why it’s really tough for perma-bears to tell us they expect the 2009 lows to be taken out. There is absolutely no way to predict it. Why? Simply put, it’s absolutely impossible to predict where complacency or fear is going to show up. As you know when we got to the black swan debt ceiling spectacle there was no more talk of soft patches. Now we are starting to get the 1929 comparisons.
How can we reverse the current situation? If markets can drop on complacency they can certainly rise on fear and worry. That’s called a wall of worry. It’s also impossible to predict but if a market suddenly rises and the VIX doesn’t drop then we can turn more bullish.
Gold got hit and that’s really the next biggest story of the week. This is purely an inflation/deflation play. Gold dropping along with oil is suggesting that deflation is once again rearing its ugly head. As long as the Greenback doesn’t break free from the levels of last week’s high it’s not a problem yet. But we are coming to the point where it can become a problem. I’ve been telling you for nearly 3 years that as long as the Dollar is kept in check in the larger trading range conditions in the recovery can stay in motion. Now we are halfway up the range. Because conditions are fragile with Europe we still have a buffer in the low 80s’ but who really wants to see it cut so close? I think that if the Dollar gets above the approximate 85 level you can see some serious fear levels in the stock market. Based on what we’ve discussed here that can’t be a prediction but really a hypothesis. If the Dollar goes to 85 and the VIX would continue to drop I think we would be in big trouble.
Next page: Where might gold go?
I think Gold does have the potential to drop more but only if the Greenback breaks free. Suddenly, we don’t see so many commercials for gold on television, do we? There is no such thing as Gold being the new reserve currency of the world. If and when that’s the headline it represents a severely extended market.
Overall, we saw a bounce attempt on Friday due to the 161 day trading window back to the May peak. We were looking for it but the rally faded in the middle of the session and what was a promising start became a struggle. Biotech and banking gave up early gains.
What can we expect moving forward? One of the major wild cards is Shanghai. As we know it’s a non-participant in the Santa rally. Up to now they have the Grinch spirit. But Friday was a day where it put in an excellent reversal candle on some good square of 9 and ratio readings not only off the February high but the 2010 high as well. These peaks are not the 2009 high but of a seconday nature so any rally from here would be anticipated to be a multi-week bear market variety. This is how we reconcile the Chinese Premier’s comments of a week ago. We already know to be concerned about their opinion of having inflation under control. However, that has nothing to do with intermediate level swings in the market. In the bigger picture, this is a classic bear market. However, the good readings in China are a double edge sword. In early action on Sunday night the SSE gave back a portion of Friday’s gains. The higher probability is on a turn window with readings is we should see a change in direction, especially when it comes from the bottom of a pitchfork line. However, in the non-linear world of financial markets conditions hardly conform to expectation. If really good readings are violated, they could mean something much larger is developing and it takes a really strong underlying current to overcome good readings. I’m looking at 1 of 2 conditions. Either China really turns itself around here or the pattern can seriously accelerate lower from here. The higher probability doesn’t always win. But I’d handicap the percentages as 3-1 in favor of a change of direction. But we are going to have to see these approximate levels in the SSE take root.
What this means to us is whatever the outcome is likely to determine whether we see the risk on/off trade. If China turns itself around it will affect the mining/materials heavy Australian market which will in turn impact Copper which have the butterfly effect to the Greenback and ultimately to our equity market. If China withstands this retest of last week’s low, you should know how to get positioned.
Click chart to enlarge
Jeff Greenblatt is the author of Breakthrough Strategies For Predicting Any Market, editor of the Fibonacci Forecaster, director of Lucas Wave International, LLC. and a private trader for the past eight years.
Lucas Wave International (https://www.lucaswaveinternational.com) provides forecasts of financial markets via the Fibonacci Forecaster and other reports. The company provides coaching/seminars to teach traders around the world about this cutting edge methodology.