Stock market action bolsters case for a top.

The tide is turning. We now have a strong, impulsive decline off the highs, confirmed by a rise in the dollar and declines in the metals, energy, and grains. Yes, we’ve seen this before (in June, August and September), but the sustained manic conditions (put/call ratio, DSI, etc) that we saw in mid-September and mid-October are unlikely to be revived. When momentum runs out and there are no fundamentals to offer support, stocks can fall under their own weight. They don’t need a catalyst.

The Russell 2000 (like the SPX and Nasdaq) has just busted through its big support line drawn from the March lows to the July lows:

Source: Interactive Brokers

The SPX (S&P 500) has put a toe over the same line, while the Dow has a bit to go. Here’s the SPX:


Things are looking very bearish intermediate-term, but for the next day or two, I think the odds favor a small bounce. We’ve had two strong weeks of declines, and the overbought, over-bullish condition is cleared for now. I’m long stock futures (and a touch of oil and gold) from today’s lows to hedge my put position. Positioned like this, I get no benefit from further declines, and preserve equity to re-short any rally.

Remember, if this decline resembles that of ’30 or ’37, ALL of this year’s gains could be wiped out in a mere three months. If this is wave 3, it could be much faster than wave 1 (Oct 2007 – March 2009). It marks the start of the worst part of the depression. If you know anyone who owns stocks or is thinking of getting back in, implore them to seek safety (Treasury-only money market funds). Likewise, right now may be the last chance in 20 years to unload real estate at 2003 prices.

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21 thoughts on “Stock market action bolsters case for a top.

  1. You’ll see the market cheerleaders come and announce it’s a great opportunity to buy the dip. So I am still not convinced this break out is the real one, but I am positioned accordingly:

    Likewise, I’ve been making some bucks on my long USD, short SPX and Russell positions. The dow is still quite resistant though… Still holding gold and silver as hedges, but silver is near a major resistance…

    Also opened a small short on BIDU at the market close today…

  2. Mike: In ‘30 or ‘37, was the GDP (3%+) growing before the crashes? Just curious. Apparently, we have exited the recession in Q3. LOL!

  3. As I’m sure you’re aware, GDP is a bullshit indicator. If the government spent a few trillion more, the figure could be +10%. How does that indicate production, as in “gross domestic PRODUCT”?

  4. Karl Denninger has a good deconstruction of the GDP figures today. The fact that consumer spending has been 70% of GDP already tells you something is terribly out of whack. If I ran my household that way (70% spending, 30% production), I’d be broke in no time.

  5. I haven’t looked at the market that much lately, but I think right now might be a good time to add to medium term dollar long (vs. pound, euro, and aussie, and kiwi).

    From Rosie the soi-dissant “perma-bear”:

    The man on the street sees it a little differently, perhaps less enthused by the fact that a lower rate of inventory destocking is arithmetically underpinning GDP growth at this time. Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go — and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

    Only 29% of those polled believe the economy has hit bottom — imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally — not the onset of a new bull market) has not swayed their view (or ours for that matter). There is going to be some very tough slogging ahead as far as the economy is concerned.

    Rosie, the “permabear” gives a good case (although not explicitly) that we aren’t ready for the bear’s wet dream yet. Still, too many people are bearish…

    I think we need a 10-15% decline (from the recent top) to give the shorts some confidence, and to cause another frustrating market rally to finally break their will (if it hasn’t already). I think we need to decline more to create another bear trap. Yesterday’s rally hasn’t falsified this view, although I do think (currently) that last week was the high for the year. That rally needed to test the will of the bears of went out of hibernation, and it is not surprising that large daily moves occur during corrections as volatility increases. It seems the recovery trade is somewhat popular (as most investment banks recommend the trade), and it worked for two quarters. Even if I am wrong, the risk/reward for the proposition that last week was the high seems good, since it seems that most of the shorts are out, and the Pavlovian effect of the “better-than-expected” earnings would wane.

  6. Of course… asking ordinary people isn’t accurate, and it does have limitations of using it as a proxy sentiment indicator. For many people, economy = labor market, and economy = commodity market as many face the labor market directly, and commodities indirectly (mainly energy in this case.) The labor market is not the stock market, and it isn’t contrarian to state the obvious about the labor market. Even economists who do believe in a recovery use the adjective “jobless.”

  7. Graphite, your bbg link doesn’t seem to work.
    Nonetheless, as long as there’s no new top and key resistance levels are not broken, the case of a top is strong.

  8. Aki_Izayoi, agreed on the US. I’ve bought some USD sold EUR at 1.49xx (reverse of my position until a few weeks ago). Didn’t think the USD would rally so quickly, so my position is about one 5th of what I’d like it to be, but it might a good buying opportunity at these levels again.

  9. I am still bearish…

    Five reasons why I am bearish:

    I. Short interest is relatively low and it seemed to have bottomed in October 2009. From the linked graph, short interest has further to go.

    II. Money managers are generally bullish.

    III. The market is still not oversold as the MACD hasn’t breached zero on SPY yet, the RSI is still at 40 though, but I do not expect this “correction” to result in a “panic bottom” where the RSI sinks below 30. I assume panic bottoms do not happen when the crowd is still already skeptical and bearish during the peak.

    IV. During uptrends, in order to outperform one must buy the dips. In order to do this, one must convert the cash in a portfolio to stocks, sell something else in the portfolio to buy stocks, or borrow money to this. A correction will trigger stop losses to force even more selling. The bullish fuel that made people buy the dips by either of the three means seems to be exhausted.

    V. Volatility will discourage people from taking short positions during a sell-off as they do remember the pain from shorting early in July and the rally on Thursday this week, but if is positioned from shorting the market at a top, then one would not have to worry about whipsaw. This volatility would force the weak long positions to sell, and result in a gradual rise in short positions.

    Again, I do not see the bear’s beatific vision coming. Inflows into bond funds are still high, and the crowd remains bearish overall. The market has a built in sentiment support, or perhaps, low interest rates allow one to put high multiples on stock.

  10. FYI, I went heavily short again near Thursday’s highs and hedged up again late Friday. I’m ambiguous about next week — I’d like another little bounce to lever up short again, since I think this move could take us to SPX 1000 before a good rally.

    Overall, this is looking very good for the bears. We just need good set-ups for the right risk-reward profile to get short with clear stops.

  11. We have no idea how this is going to play out — rolling top like a 2007 redux, maybe, or maybe ’30 or ’37. Even odds in my book, but I think crash conditions will return sooner or later in either case, and the SPX is headed for a date with value.

  12. Hi Mike,
    I am new to this site but I have read some of the older posts and I like your insights. I have a question: I am not a speculator but seek safety. You mentioned in today’s post Treasury MMF. As an alternative, what do you think of SHV and/or SHY? Is there something about their structure as ETFs that makes them less safe? Also, I hold a GNMA mutual fund. It has done well through this mess so far. What is your opinion on the risks there?

    Thank you,


  13. Hi Allen,

    You would have to dig through the prospecti of those ETFs to determine their real asset structures, and furthermore, you assume the risk of your brokerage going under if you go that route. It is much safer IMO to just buy into a Treasury-only MMF like those mentioned in that popular post listed at the top right of the blog. You then have a clear ownership claim and can write checks straight from the account. There is also Treasury Direct, though I don’t have any experience with it.

    GNMA funds depend on the US continuing to back up that (generally risky) debt. The advantage of short-term Treasuries is they will be the very last paper to be defaulted on. Basically, the government will have to topple before they go bad (and if that is coming around the corner, you want physical gold).

    I hope my opinion helps.


  14. Thanks for your thoughts Mike (and Graphite). I read the Treasury MM article in the Most Viewed list. I definitely use a Treasury MM for a large portion of my assets. I am trying to sort out if any other bonds still have a place in a conservative portfolio, like GNMA, or 2 y. Notes.
    I have in the past resisted the idea of holding gold. I have to find a place to put it, no interest, etc. But I am thinking it is a good idea, for the reason you suggest. I might like to buy at a lower price however. Maybe me reaching this decision indicates a top for gold:)

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