Stock market sentiment, time windows say correction coming

Fibonacci Forecaster

I suppose market timing works after all. I’ve spent a good deal of the past couple of weeks working with clients in the realm of psychology and sentiment. Great traders feel fear like everyone else. They just tend to know what it means and what to do with it. Same with euphoria. Tom Hanks had it right. There’s no crying in baseball, and there’s no such thing as happiness in the stock market -- that is, if you are still in your positions. It’s perfectly fine to be happy after you hit the SELL button.

So I analyzed my own feelings and started getting frustrated with the timing cycles because they appeared to stop working. My own feelings of frustration translated to a market that finally hit an extreme on the back end of the 233-week window off the November 2008 bottom. We finally got a change in direction. The change finally manifested as the bond market started getting hit. Interest rates seem to have started a slow ascent, which is not good for housing.

At one point last week, housing and banking stocks were going in the opposite direction. That had me scratching my head. But let me put this in perspective. Here in Phoenix a house that went for $225,000 six to nine months ago is now going for $295,000. The problem is income and job growth has not escalated to keep pace. If income can’t keep up with rents, aren’t we inviting the same problem we had six to seven years ago? Haven’t we seen this script before? Like Hollywood, the sequel never ranks up to the original, but some of these movies do end up with the same bad ending. Now if we consider that same $295,000 house being financed with the higher interest rate, that certainly is outpacing income and job growth. Is it any wonder folks who trade housing stocks are starting to get spooked?

Until Friday, charts like the SPX were forming what amounted to bullish triangles but the late day breakdown ruled that out. Folks, we have ourselves a change of direction. According to my calculations, this is a correction in a bull market. This high is not nearly as powerful (in terms of calculations and symmetries) as the one we had last fall or even the one we had in March.

Probably the best calculations are in the FTSE so that means we are losing European leadership. That wouldn’t be such a big deal but we are also starting to lose leadership in other areas like transports and housing stocks. For a market to keep rolling it needs the leadership groups that created the party. To use a sports analogy, when a team hits the playoffs they continue using the formula for success to go deeper in the playoffs. If they suffer injury to a key player that’s going to hurt and quite possibly be a knockout factor. This market is now losing key players in Europe, transports and housing. Simply put, we are losing what brought us to the party.

The other problem in terms of sentiment is easing issue. The Fed is threatening to end its bond-buying program. Let’s face it, equity players are addicted. The economy might be addicted because they need something to offset the austerity going on in Washington. My more than hypothetical question is if not for Ben Bernanke and his loyal band of treasury dealers, who exactly is going to continue buying these bonds? It’s not like they are setting the house on fire these days.

With the long term bond chart we’ve already started to violate the major high at the end of 2008. That’s not what I’m concerned about. Look at the brown rising trendline. That’s a sequence that could get us down to about 125-130. If that happened, we’d see a spike in interest rates that certainly wouldn’t be appealing to people trading housing stocks. But it’s what comes after that has me concerned. Look at the left side. We’ve had a series of rallies that have had steep retracements, all of them. It’s a choppy chart. In our work, none of them makes really good support should we have the bull market end.

I’m concerned that after trendline support breaks, we can have acceleration from about 125 to 80 in an abnormally short period of time. In other words, some of you would call it a waterfall. Let’s just a spade a spade, I’m concerned for a crash in the bond market. Not today or tomorrow but perhaps in the next couple of years. After all, this is a monthly chart we are looking at. If we did end up with a move from 140 to 125 we’d likely experience a major rally that would consume six months to a year. I just see the potential on this chart for something to happen.

Because the bond market can be inverse to stocks and also rally on poor economic news, a crash in the bond market would likely happen before a major downturn in stocks. By the time a crash in the bond market would finally bottom, sentiment would be such for a crummy economy which would mean stocks would go lower but likely create a lasting bottom in bonds. Like I said, this is not for today but when I look to the current bond market starting to break down and I look to housing stocks that are getting skittish, I see seeds being sown.

For now, we have major time windows in the stock market once again hitting in the fall. Could such a crash happen this year? It doesn’t seem likely but it would all depend on how long it takes this long-term chart to break down from trend line support. But what you see here is going to be the risk going forward. It’s been a 32-year bull market. It has to end sometime.

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