Shades Of A Stock Market Mania
The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, April 15th, 2010.
In the pushing it to the limit department, as some of you may know, I am caring for an aging parent right now (and experiencing rapid mental decay), and yesterday was one of those days that commanded all my time until the wee hours of the morning here. Thusly, this will be short, but sweet. And this is quite possibly the sweetest shorting opportunity in stocks since the tops in either 2000 or 2007, as key measures are indicating we definitely have 'shades of a stock market mania' that in fact go beyond the two tops witnessed last decade. Let me explain as succinctly as possible in an attempt to get this out to you before trade begins in North America this morning.
As anticipated earlier in the week, and before, stocks remain buoyant into options expiry tomorrow, with recently rising US index open interest put / call ratios providing the fuel for the present short squeeze, which is going quite manic (extreme, choppy, unpredictable) indeed with the S&P 500 (SPX) comfortably over 1200 now. And you know what, this might not be 'the top' for the larger reaction higher off the 2009 lows either, where as mentioned previously, the news is just so bad out there, that increasing numbers of straightforward thinking speculators not familiar with how these things work have been in shorting stocks for some time already, providing the fuel to take us to this point, which may persist. The key then, in terms identifying a profound top, is measuring the exhaustion point of the fuel for the squeeze, these unaware speculators, which we of course have done accurately by monitoring sentiment via US index open interest put / call ratios.
In spite of the fact next week is the first week in an extended options cycle (5-weeks) during May, which can have an impact on how the month matures, still, after tomorrow, bulls and price managers alike will not have the rubes presently caught in the squeeze to prey on anymore, with the influence of the next options cycle weakest, so stocks should fall next week no matter what, even if such weakness proves only temporary. How this turns out depends on whether the unaware speculators mentioned above react moving forward, whether this squeeze is enough for them, where open interest put / call ratios will trend lower, or whether they continue to view the stakes being 'so high', they need to lose more money on a collective basis in order to be able to sleep at night. Again, we will be sure to keep you abreast of the post expiry ratios next week, and past, in continuously gauging effective sentiment and the potential for profitable short selling probabilities moving forward.
And again, in this regard, because we are hitting such an obvious extreme running into expiry tomorrow, even if unsuspecting short sellers return in May, next week should see a reaction lower in stocks, which could be the beginning of something considerable in scale if the bears are exhausted. It's important to understand we are approaching a point where the bears will simply be so exhausted from the trade that they will literally be thinking they need to take the summer off to recoup, and stop buying puts. So if this doesn't happen in May, it will definitely occur in June once the weather in Northern longitudes turns warmer, melting exhausted bear's resolve. And that's all the market will need to finally start heading lower in earnest. The market will never pay the majority - only the well studied and vigilant.
In using technical analysis to aid us further here, again we bring in the CBOE Volatility Index (VIX), that is understandably running some serious divergences given the degree of mania presently gripping the market, undoubtedly one of the more profound extremes ever witnessed in the history of financial markets. As you can see below, at present, we are witnessing the VIX exceed standard Bollinger Band (BB) parameters, which has historically signaled an impending turn in direction due to speculator capitulation. So again, even if the bears are not finished in their losing ways, the VIX is due for at least a short-term rally beginning next week, so traders should position themselves in knowing this by tomorrow. (See Figure 1)
I will not list all the ways one can do this, with so many available (outright short sales, puts, etc.), however for most, one of the index based ETF's is likely best. We have a few listed here in our Short Portfolio found in the Markets Chest for US and Canadian accounts with updated pricing, targets, and market dispositions. You will note we are now officially bearish across the board from short-term to long. This is of course not a difficult call now given what has happened. Never the less it's still profound given we avoided being squeezed, along with the fact we are at a significant Princeton Economics Pi turn window, adding to timing importance / degree. What's more, the following chart adds to degree in my opinion as well, which will be explained below. (See Figure 2)
What is the significance of the above chart? Firstly, one must appreciate where Goldman Sachs (GS) fits into the big picture, being the quintessential financial stock to own for a decade as measured by it's increasing out-performance over the past ten years. And it's no secret why this has been the case, having ex-employees taking such lofty official positions around the world throughout this period as a matter of corporate strategy, typified by Paulson as US Treasury Secretary last year, in charge of steering the bailouts to ensure his brethren remained whole. What's more, because GS is not just any financial, but also a hedge fund conglomerate and bank all rolled into one, again, it's the quintessential financial, meaning it's essentially a measure of the health of the whole (market).
So, the fact it hit a Fibonacci (Fib) signatured resonance related target ahead of a top in the broad market(s) cannot be taken lightly, where in fact inquiring minds would consider this divergence telling. And while such an occurrence could be accounted for in GS falling out of most favored status with their buddies in Washington due to political necessity now that the public has had enough of this self-serving horse pucky, given the totality of the situation, with the present mania center stage, such thinking could prove dangerous if one is thinking The Boys From Brazil (the GS boys and girls), will ever regain such favor. And if they don't, which is likely, the fact this quintessential financial is essentially done should not be taken lightly, providing further profound proof of potentially significant trouble in stocks - dead ahead.
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Good investing all.