THE BOTTOM LINE
Events of this past week suggest the growing signs of rally fatigue may soon give way to a more volatile market environment, and possibly a potentially significant decline resulting in a low risk buying opportunity, or alternately additional signs that at least a leg up in the bull market is ending. If increasing volatility results in opportunities for intermediate, or longer term trades, then we will execute those trades. If volatility leads to more weakness in an array of market measures, then we will stand aside until more favorable risk/reward metrics appear.
Investors should expect volatility to increase as early as next week.
BIG IMPLICATIONS
On December 7, 1941 the Empire of Japan attacked the American Navy anchored in Pearl Harbor in Hawaii. In the following days the Japanese military progressively attacked, and captured large portions of the Pacific threatening to cut off Australia from the rest of those countries allied against Germany, Italy and Japan. The situation was grim, and grew worse when in the Battle of the Coral Sea America lost an aircraft carrier, and the Yorktown was severely damaged, and presumed sinking by the Japanese. The Japanese were relentlessly applying their plan to control the Pacific, and deny the Americans any base of operations in the vast Pacific, which in turn would bring into play the West Coast of the United States. The Japanese turned their attention to Midway Island in an effort to deliver a knock out punch to the American Navy.
Sometimes the greatest of events turn on small things. As the Japanese fleet was steaming to attack Midway, American Naval Intelligence had broken the Japanese radio code, and determined that Admiral Yamamoto, a Harvard graduate, was going to invade Midway. Admiral Chester W. Nimitz ordered the remaining entire American Navy, including the Yorktown needing weeks of repairs, to Midway hoping to surprise the Japanese as they attacked the island. Weeks of repairs to the Yorktown were completed in 72 hours, as Admiral Nimitz appeared among the men doing the repairs urging them to get her underway. Yorktown sailed while repairs were still being done enroute to Midway.
The Japanese attacked Midway as torpedo planes from the three remaining American carriers, plus a newly operational Yorktown looked for the Japanese fleet. Japanese Admiral Nagumo, a by the book old line naval officer, had taken the precaution to not be surprised by sending out scout planes on important compass radials just in case elements of the American fleet were in the area. The only scout plane to discover the American fleet lying in wait to spring its trap radioed Nagumo’s flag ship. The Japanese pilot’s radio failed and his warning was never received. Mean while the American Flight leader, McCluskey, was ready to turn his flight back to their carrier, when recognizing the importance of locating the Japanese he ordered his planes to change course on a hunch, and fly on even though they may not have enough fuel to get back to their carrier.
The vast Pacific was empty of ships, until a break in the clouds revealed the Japanese Navy steaming toward Midway. Over the next few hours the war in the Pacific turned, even after all the torpedo planes were shot down without scoring a hit. McCluskey had found the Japanese, and the follow on dive bombers scored hits on three of the Japanese four carriers with their decks littered with avgas and ordinance. Small things, a radio intercept identifying Midway as the Japanese target, the failure of the radio in the only Japanese scout plane to discover the American Fleet, and McCluskey’s decision to fly on low on fuel, turned the balance in the Pacific in favor of the Americans, and our British allies in a matter of minutes once the dive bombers found their targets.
Last week’s update talked about signs of fatigue in the relentless rally from the March 23 low, a rally which did pause at several Fibonacci and support and resistance targets only to find bidders swarm in and take the liquidity driven market higher. The S&P-500 candidate bear rally then validated it’s bull market credentials by touching new all-time highs, albeit in the midst of many global uncertainties, bad economic and unemployment numbers not seen since the Great Depression, and a very politically divided nation grappling with social unrest at a level, which reminds some of us of the turbulent, and often violent 1960s. However in addition to last week’s signs of fatigue in the rally, this week added a “small thing”, which may turn out to be in the tradition of small things becoming very important.
Snapshot-370 (above) shows a small triangle, which developed during last week. Triangles can be a real friend to an analyst, because if they go to completion, then the follow on outlook has a very high probability of being correct, think 90% or more probability. The text book says triangles appear immediately prior to “the last movement in a sequence, which is a short but powerful move called a thrust”. In the current case the triangle went to completion, and a case can be made that the “thrust” higher began late Friday afternoon.
Last week’s update documented the growing weakness in a number of metrics as the end of August approached. That weakness continued this past week, even as the triangle was preparing to thrust higher. None of this means that the bull market from March 2009 is in its terminal movement, but it does mean that a period of weakness likely lies immediately ahead post completion of the thrust higher. This expected weakness may turn out to be a low risk entry to put cash to work, or yes the thrust higher may be a candidate for the last movement in the rally which began on March 23, 2020, even for the entire bull market beginning on March 9, 2009. Time will tell.
Given the signs of fatigue, and this past week’s development of a complete triangle, small though it may be, investors can reasonably expect a more volatile environment ahead.
TATY — A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown above in Snapshot-369 in yellow with the S&P-500 overlaid in red and blue candle format.
TATY finished the week at 135, still below the red zone, and still displaying a yawning negative divergence with the price, which has been assaulting new all-time highs. Extremely high bullish sentiment readings, valuations beyond the pale, a NASDAQ going parabolic as its advance/decline line plunges, with a handful of NASDAQ stocks now cumulatively more valuable than all the stocks on the European exchanges, and TATY remains below its normal operating range with the S&P-500 at new all-time highs. This is as abnormal and atypical as market behavior has gotten in my career.
So, what to do? The answer is if trades representing a reasonable risk/reward ratio appear, then we will take advantage of those kinds of situations. Otherwise, we will respect the outlier statistical nature, and global uncertainties of this pre-election period, and favor preservation of capital for as long as families of supply and demand indicators remain outside their normal operating ranges.
Please stay safe!
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