Last week’s lengthy update reviewed the process of how low risks buying opportunities usually develop in the stock market according to our proprietary supply and demand indicators. The update observed that the negative divergence between the price touching new all-time highs, while several of our key indicators were in obvious down trends, had finally resulted in the price rolling over to chase the indicators lower. Then in the afternoon of last Friday the decline in the price accelerated driving our premium/discount to value indicator below minus eight. Discounts to value touching this zone almost always represent a significant enough of a discount to deploy some excess cash into the equity market. A discount of minus eight in magnitude also implies the correction likely has more to go before the price bottoms, and then commences a new leg higher. We did do some ETF purchases as part of our plan to dollar cost average into a larger equity asset allocation, as the anticipated remaining steps in the bottoming process completed, which unfortunately failed to develop before the rally back to new highs.
This past Monday the brief price decline ended abruptly, and the market rallied back to touch new all-time highs by the end of the week, giving clients instant profits on the positions purchased Friday afternoon. So is the shallow correction already over, or is the rally back to new highs a trap to be followed by nasty decline to set up the completion of the usual steps in the process of forming low risks tradable bottoms? Or, as the Time Lord in the hit British Sci-fi TV series, “Doctor Who”, once said: “Have we already been, or yet to come”. Yes, time travel can cause one to become confused as one skips around the centuries, or experiences unusual, or atypical, episodes in the stock market.
So, our clients were offered a discount on new purchases, and we did some buying in anticipation of doing more, as the usual steps in a low risks bottoming process completed. And, while an instant profit on our new purchases is a plus, there is the matter of those pesky negative divergences remaining in place, and at this point growing much more pronounced, as the price has achieved new all-time highs. This suggests the potential that only a phase of the correction may be complete, and another leg down may be required to put in place a strong foundation for a new leg up in a continuing bull trend. The next two sections will explain how this conundrum may be resolved in the days to come.
During bull markets corrections happen like breathing in and out for you and I. Bull market pull backs tend to be in the range of three percent to less than twenty, with most falling into the less than double digit percentage range. Bear markets, generally accepted to be defined as declines exceeding twenty percent, are often correlated with economic recessions. Recessions are often defined as two or more quarters of negative GDP, but for a more complete definition you may want to Google “NBER”, the organization, which officially declares when recessions begin and end. So, when MIT released a report this past week that there was a 70% percent chance of a recession in the next six months, it caught my eye. There’s a 70% chance of recession in the next six months, new study from MIT and State Street finds. Click on the link to read the article. Obviously, the longest recovery in history implies that a significant stock market correction, and/or economic recession is overdue relative to history.
TATY — A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown above in yellow with the S&P-500 cash index overlaid in red and blue candle chart format. I have left the orange lines indicating negative divergences in place, because they are likely still telling us important information. TATY bottomed marginally below the red zone surrounding the 140 level and finished the week at 145. Long time clients know that when TATY is painting out bottoms in, or near, the red zone, rally attempts are likely to follow.
In the current case, a new rally attempt has assaulted, and then the price touched new all-time highs, rewarding clients with instant profits on the purchases made during the accelerating decline of a week ago Friday. However, investors will notice that the new rally high shown on the chart looks a bit lonely, because the confirming strength of the demand represented by the TATY indicator is lagging way behind. If the rally is to continue, and possibly accelerate, then evidence of strengthening demand must arrive soon in the form of a better confirming rally in the TATY indicator. Should the negative divergences shown on the TATY chart remain, or grow worse, then the rally back to new all time highs may only be part of a bull trap, which may then be followed by a persistent and accelerating decline. The outcome of this conundrum will likely take some time to be known.
The bottom line for this section is the continuing negative divergences shown on the TATY chart by the down sloping orange lines imply that perhaps only a phase of an on going correction has been completed with possibly another leg down yet to come when the intervening rally expires.
SAMMY — A REPRESENTATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS
SAMMY is shown above alone, and below with the SPXL 3X S&P-500 ETF overlaid. The SPXL is for reference only.
The conditions for the effective application of the SAMMY indicator never appeared during the fleeting three percent decline in the price, so SAMMY is shown this week for information only. SAMMY becomes critical when there is evidence of exhausted sellers in determining re-surging demand has begun. Since at this point there has been scant evidence of exhausted sellers, SAMMY is of no applicable value to us. However, I would call investors attention to the fact that the negative divergence discussed in the TATY strategic section exists also with SAMMY in the tactical section. The negative divergence is shown by the orange down sloping line on the second chart. So, SAMMY, in like manner as TATY, is suggesting to investors that the rally back to new all-time highs is so far unconfirmed by objective evidence of gathering strength in demand in these two important representatives of supply and demand indicator families.
THE BOTTOM LINE
Recent purchases made when our premium/discount indicator reached the minus eight level, a level indicative of the existence of reasonable discounts to value, has reward clients with instant profits. However, the subsequent rally back to new all-time highs has yet to be confirmed by gathering strength in a number of supply and demand indicators, which suggests that perhaps only a phase of the correction has been completed, and another leg down may yet develop.
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