PII…2 down and 3 to go. Bears cover and Spain locks in their bailout, just at the point in time markets come down to similar support levels during last year’s crisis. Is it just me or do you think it’s really true that bears lack the conviction to take it all the way? Last week it didn’t take much to tweak the bears as all we needed was a press release from Janet Yellen to send bears for the hills in the form of the one of the best market days of the year last Wednesday. On Thursday Bernanke went up to Capitol Hill to pour cold water on the whole thing but by Friday bulls didn’t need any excuse to take markets higher.
But as we get a week closer to the seasonal time window there are 3 conditions that still concern me. First of all, it’s the turn window itself. Any time we rally into a major seasonal point in a larger degree downtrend we run the risk of inverting and topping out. Second, I’ll throw out a couple of news events which could serve to scare markets, next week we’ll have elections in Greece and Egypt where a potentially hostile to Western interests group can win power. Finally, we have a VIX that peaked in the 27 handle but fell back all the way to 21. The bottom line is based on the positioning of the VIX we are not set up for a fresh bull leg that can sustain beyond the higher end of the range. That could change if we get a major shake of the trees with these elections, but it’s not the way things look right now.
But the biggest factor working in the equity market’s favor as I write this late Sunday night is the gap down in the Greenback. When the Greenback topped on decent Gann readings the initial last man in group who bought near the highs got trapped as you can see from this chart. Once the price action fell below the last ridge of support before the high, all of those traders who didn’t use stop losses probably wish they had. If that happened to you, what would you hope for? Just to breakeven and you’d never do it again, right? These traders did get that chance but it appears some of them stubbornly held on because it dropped one more time AND CAME RIGHT BACK UP. Given the point on the chart where prices dropped we see that former support became resistance and polarity flipped. That means we had the last group near the old high give up and the next group which may have thought they were buying a dip. That group of traders was stubborn as well or else the price action could not have rallied again. Granted, this is not the classic unwind of distribution but the gap down now has the price action sitting under the market. If it comes up to the 82 handle and drops or if it just covers the gap and drops then we likely confirm a top. However the price action is slowly becoming supportive of a larger move for stocks.
Getting back to stocks, Sunday night’s action is positive on 2 fronts. First of all, as we stated last week, prices had come all the way down to the October peak and as we know, not a lot of buyers supporting the market below in a zone down to the October low. What was the market up? Quite frankly a lack of bearish conviction which made the whole support zone very shaky. Here we are with the Spanish bailout and longer term bears are starting to show the same kind of indecision they showed last year all over again. That doesn’t mean we aren’t going down there, just not right now. On the other side of the coin the NQ has now cleared all near term overhead resistance during the Greek sequence from a couple of weeks ago which led to the last breakdown. This rally ought to at least test the upper third of the range. As I write this the NQ is sitting at 2585 and the A wave tendency low from April 23 is 2619. In the very least this bounce should test that level.
Another chart that had zero margin for error was the EUR-USD which had a beautiful flip in polarity to it’s A wave tendency line on Sunday night. As you can see from this chart the initial burst off the bottom is the A wave (we rule out the subjectivity of Elliott). Prices came back to retest, lifted again and by Friday made a 2nd test of the line. It was either going to happen or it wasn’t. By Sunday night the retest of the line confirmed the polarity flip and prices exploded higher, likely a combination of buying interest and well as a short squeeze.
Next page: What was behind the drop?
The bottom line here is however you slice it, everyone is in agreement there is no more selling interest going back to the low which raises the probability the fear based lows were a combination of mild panic and perhaps some forced liquidation as well. By default, if it isn’t going down, there’s only one other way for it to go. But given the Spanish news this is more than likely a short squeeze. What that means for the time being is they took the weaker bears out of the market and the only likely bears still in the game are the longer term ones who are better positioned in the middle to the upper end of the range. That opens the door for higher prices. But if they can’t push it beyond the middle to top 3rd of the range, stronger hands will attempt to take it down again. The bottom line for Europe is we still can’t rule out a move to the 1.2000 handle but more than likely the time deadline has changed. We may not see such a move until later in the year.
Overall, I don’t think that currency or equity European bears have given up, probably just a case of hibernation. IF the VIX falls below 20 the first part of the week odds greatly increase for a peak in this rally in about a week or somewhere in the top 3rd of the range or a combination of both. The only thing that could change my mind with this bit of information is if the wrong parties win these elections next week and the market starts to rally. I’d much rather see the market rally on a wall of worry then ride the slope of hope which it’s doing right now. When down trends end stall and then rise on good news, that’s not a good sign no matter how good the action is.
If you get nothing else out of this post, I want you to think of one thing. When markets started rising for real in 2009, the media spent an inordinate amount of energy asking many guests if they thought a double dip recession was in the cards. Markets rose on worry. Right now they are rising on the emotion of relief. We feel relief that Spain is getting bailed out and rightfully so. However we have to look at the price action and figure out what is driving the bus. Right now its short covering and I doubt fund managers are committing new capital to this market. The only time they likely get the courage to come in is if we consolidation or some test of the low that isn’t taken out. Fund managers are not traders and they need to see that the water is warm. They chased performance last year and there is no reason to believe this time is any different.