Finishing Touches (Market Top)

In a classic example of the power of Short-covering, the S&P 500 has risen 190 points in just 16 sessions. Market valuations remain at historically extreme levels, so it’s not like the markets are cheap and investors are rushing in to buy value. The economic news remains uninspiring, and announcements continue to re-enforce a recessionary or low growth environment. So once the Short covering has run its course, the only catalyst for a continued rise in equities (back to 2,000 and above) would be the idea that the central bank will become more accommodative again. To some this is bullish behavior, for me, the market is putting in some Finishing Touches (Market Top).

In a case of bad-news-is-good-news for the markets, it’s clear that equity over-valuation exists because of FED policies. For several years, the FED has responded to bad economic news by increasing liquidity, and this has pushed asset prices higher. But the FED’s ability to safely provide liquidity is not unlimited, and it appears that the FED’s powerful accommodative policies have been exhausted for now, leaving asset prices vulnerable at current levels. Unless economic announcements become much more negative, forcing the FED steps back in with some sort of stimulus, the bear market in equities will almost certainly continue.

Since 2015’s broad topping pattern, equities have frequently moved sharply in both directions. The extreme nature of the moves makes predicting the day-to-day markets extremely difficult, which is why traders find it so difficult to profit in an environment like that we have today. In the short term, however, Daily Cycle timing and the market’s overbought status greatly favor a reversal and decline toward the next DCL.

The Financial Tap – S&P Daily Chart

There is clarity again in the S&P’s Investor Cycles, especially with a Three White Soldiers pattern in place. Three straight weeks of solid gains have lifted the S&P sharply to close back above the 26-week moving average. The current rally will draw the bulls back in and swing sentiment back to the bullish side, setting up another decline.

Since I believe that equities are well into a bear market, the recent strength should be seen as only counter-trend. We’ve had 2 significant Investor Cycle declines since August, and it appears that we still have some upside “filling” to do before the longer term bear market decline continues. The next step is a Daily Cycle Low decline, which should get bears excited before price launches in a new DC. I expect the new DC rally will push the S&P back above 2,000 and form the top for the current Investor Cycle.

If this scenario unfolds, I’d expect sentiment to once again become too bullish, at a time when the equities Cycle has the time and room to sell-off in a confined fashion. But this scenario is not a given – if the bear market is underway, greater-than-expected downside risk is always present and the bottom could fall out of the market at any time.