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Recent weekly updates have discussed that Christmas Eve was very likely a key day to remember going forward, as there were a number of important signs on that day, and the following business day, that at least a short term market reversal had taken place. As you may remember, December 24 and the previous couple days, had all three painted out consecutive 80% downside days, which were followed on December 26 with an eruption of demand setting a record for a Dow one day point gain. So this brief period of time bore evidence of exhausted sellers and rejuvenated demand, which in my discipline I’ve applied successfully for years, constituted a market reversal day. TATY, a supply and demand indicator, also spiked intraday on December 24th to 101, just one point shy of the green zone surrounding the 90-100 level, a very rare event. All ten previous excursions into the green zone by TATY, since the 1990s, have been followed by new all-time highs, albeit sometimes after a “retest” of the low. Given the strength of the rally since December 24, a retest of the low looks like a very low probability. So the very short duration (marginal) bear decline is over, and a new leg in the bull stock market is now underway right? Well yes there is some objective evidence that this maybe the case, but given the multiplicity of options for the development of big bear trends, a more insidious and very dangerous option may be afoot as well. Today we will take a look at how the two most probable options may develop vis-à-vis a series of supply and demand indicators. Please remember the two most probable options do not rule out the possibility that something entirely different may develop, such is the nature of bear markets.

First let us take a look at the bull case and the notion that the whiff of panic leading up to the December 24 cathartic type bottom may have birthed a new bull leg to new all-time highs. Recently the events surrounding the December 24 low were investigated with an exhaustive comparison to similar events over the decades. This created a very favorable bull case. With the exception of more marginal positive results, surrounding the uncertainty of war in the 1940 decline, the following weeks and months the stock market went on to post very favorable results, and in some cases dramatic results. Nothing is perfect in this game of probabilities being played by the brightest of the bright, but the research clearly slants the odds in favor of the bull case, at least for the time being. However, for the bull case to continue the newly minted bull leg must continue to prove that demand has the upper hand over supply by painting out higher highs and higher lows, both in the price of the S&P-500, and in a series of supply and demand indicators. And, given that the rally off the December 24 low has now arrived at a very important series of resistance levels, a test of the ability to paint out higher highs and higher lows is now at hand.

The first attachment above shows the decline from the all-time S&P-500 high at 2941 to the December 24 low at 2347. As you may recall, a previous update discussed the work of a 12th century mathematician named Fibonacci, who discovered an important number sequence and ratios, which occur both in nature and the markets. The chart shows that the rally off the December 24 low has now reached the popular 62% retracement level noted in Fibonacci’s work. The implication is that the rally may begin to struggle at this important math resistance level, so from our perspective the test to paint out the first higher low may be at hand? Clients should not be surprised if the fist half or so of February maybe consumed by a listless market, which may trade marginally lower. The problem is the supply and demand indicator, TATY, is once again showing signs of struggling near the red zone surrounding the 140 level, a behavior often associated with the expiration of major tops. So the test ahead is an extremely important one, because remember both the price, and a series of supply and demand indicators, must both paint out higher highs and higher lows. Stay tuned as this important test will very likely chew up a good part of February before a verdict will be issued by the market. So the bottom line for the bull case is the bull is likely to be tested here at the 62% retracement level, and to pass the test for this leg up, both the price and the indicators must paint out higher lows in order for the bull case to remain the highest probable outcome.The bear case makes the next 30-90 days or so a really critical time for investors. The bear case at the moment is the lesser probability, but clients should consider the probabilities to be on a sliding scale and not static. The bear case is subject to moving higher on the scale of probabilities, and perhaps rapidly so. Please take a look at the third attachment, which is the supply and demand indicator, TATY, shown in yellow, and the S&P-500 cash index overlaid in red and blue candle chart format. You will notice immediately that TATY finished the week at 147, a marginal improvement over last week’s 146, but far short of the zone beginning at the 150 level depicting very strong demand. Given the math resistance at the 62% retracement level, and the expected consolidation of the gains from the December low at 2347, some give back in TATY will likely occur coincident with the expected digestion of the recent gains in the price. However, this raises the short term risks given the history of the red zone being where bull trends go to die. Should both the price and the indicators form a higher low in February, or March if tardy, then the next significant resistance is not far down the road at the S&P-500 2888 level, where the previous counter-trend rally failed, and then finally the all-time high at 2941. Given the escalating number of resistance level directly ahead , a more ragged drift higher may be in the offing, if this rally is only part of a larger bear market. The larger bear market option remains a lower probability subject to seeing how the supply and demand equation shifts here on the cusp of what I consider to be a very large and significant danger zone.

Well Gregory that is all fine and good, but please tell me what you intend to do with my wealth! OK here is the very hard reality of dealing with the uncertainties of the stock market. Investors must constantly measure the risks of lost opportunity costs with the very real and instantaneous costs of becoming entrapped in a bear market, particularly a bear market, which has finished its prelude and is about to get down to the business of creating a violent vortex of panic, and the mindless program selling attendant to global investors in panic mode. If the market has not begun a new bull leg, then the prelude for the bear overture is nearing an end. The bear market could re-manifest itself right here, if TATY stalls near the red zone, and then fails to form a higher low along with the price. Alternately, and the more dangerous and insidious option, and bear trends are prone to take the most insidious and destructive path, the market squeaks out a marginal new all-time high, which will end the bear prelude, and investors last chance to escape a steep, relentless and violent decline, which may even begin with a significant gap down on some kind of newsy event. Please remember that the maximum and fastest destruction of investor wealth happens not in the prelude of a bear overture, but in the free fall of the finale, as countless global investors scramble to get through a very small door to safety. The numbers I published recently, based on reasonable Fibonacci projections, was a bear decline of 30-50% from wherever the final high is touched, not a prediction, but objective math applied to the important known price levels created by the market itself.

So here is the bottom line, for now we will keep your portfolios invested, as the bull case remains the most probable . The research is also supported by the history of positive results following a rare intraday TATY excursion into the green zone surrounding the 90-100 level, and for now a one point miss at 101 is close enough to tip the probabilities in favor of the bull case. However, navigating the stock market is not an exercise in getting married to a notion, but one of changing as the probabilities move up and down on the scale of probabilities. If the bull case proves itself, then demand will likely surge, and the resistance zones discussed above will not stop the rally, and once breached the bull will likely accelerate higher, as the under-invested scramble to get fully invested, a situation where he, or she, which hesitates becomes subject to paying an accelerating lost opportunity cost. If on the contrary, the market cannot generate strong and increasing demand, especially in the zone surrounding new all-time highs, then Alexander and I will be compelled to conclude that we prefer exposing clients to the risks of lost opportunity vis-à-vis to the risks attendant to a melt-down type final leg in a large and mature bear market. Remember, when a bear is done with the overture, the finale gets ugly quickly as panic is one of our strongest emotions. Now clients know why this update is entitled “On The Cusp”, because we very likely are!

Optimist Capital

Phone: 561-771-8077

Fax: 561-771-1145


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