"And if you look away,
you'll be doing what they say.
And if you look alive, you'll be singled out and tried.
If you take home anything, let it be your will to think.
The more cynical you become, the better off you'll be.
Something to believe in."
~ The Offspring, Something to Believe In
The recent rally has been
breathtaking, however the majority of investors have missed out on a large
portion of these gains as significant levels of cash have been either moved
to bond funds or taken out of equity markets consistently during this rally.
Let's face it, financial markets around the world are not what they once
were.
U.S. equity markets in
particular are manipulated by high frequency trading which is wreaking havoc
in the marketplace in terms of potential short term volatility expansions and
"flash crashes" that can be isolated to one underlying stock.
In addition to the high
frequency trading robots, the Federal Reserve is equally involved in the
direct manipulation of financial markets through record easing adjustments.
The Federal Reserve has unleashed massive amounts of liquidity while keeping
interest rates incredibly low which has produced an environment where the risk-on
attitude permeates the landscape.
As a basic example of the
failure of recent Federal Reserve policies and their impact generally on the
valuation of various underlying assets, I submit for consideration to readers
a 20 year price chart of the U.S. Dollar Index.
20 Year U.S. Dollar Index Chart
It boggles the mind to
consider that Chairman Bernanke routinely denies that the Federal Reserve has
failed to maintain what he calls "price stability." When looking at
the chart of the valuation of the U.S. Dollar against a basket of foreign
currencies, most 5th graders if given the context would proclaim that the
Federal Reserve has failed in their objective to maintain price stability.
As time passes and the
financial crisis moves further into the rear view mirror, average Americans
have varied views about the economy, the stock market, and trust in their
government. For most Americans, the stock market does not make sense because
they view the stock market and the economy as the same thing. Sophisticated
investors understand that stocks and the economy are two totally separate
issues, particularly with the amount of manipulation that has been taken
place since 2007.
This manipulation has not gone
unnoticed by the average American. Now more than ever regular people are not
only distrustful of domestic financial markets, but they do not trust Wall
Street, and for good reason. In light of this, data compiled during the
recent uptrend suggests that retail investors have been pulling money out of
equities for weeks even though prices continue to move higher. The chart
shown below courtesy of ZeroHedge.com illustrates the recent trend.
U.S. Domestic Mutual Fund Flows
The chart above shows the
price of SPY represented as the black line and equity fund inflows/outflows
as the red area. As can be seen above, retail investors have been pulling
massive amounts of capital out of equity based mutual funds over the past few
months as equity prices have rallied. The retail crowd, commonly referred to
as sheep or courtesy of Goldman Sachs "muppets," are selling into
the rally.
So why is the retail crowd
selling? They do not believe that this rally will last because the real world
around them is arguing in the face of everything that this rally stands for.
Gasoline prices are crippling the lower and middle classes further reducing
their disposable income. Higher food and energy prices paired with job
scarcity and serious concerns have begun to mount.
The average retail investor
believes the game is rigged at this point and the everyday investor is only
helping Wall Street bankers fund their lavish lifestyles. Ultimately, the
retail crowd likely believes that the only way to win the game is to simply
not play.
Will time prove the supposed
sheep wrong? Statistically one would think so, but in this case the retail
folks may just be right. Headwinds surround the global macroeconomic
landscape. Europe is moving into a recession which is being exacerbated by
austerity measures. Data came out yesterday (Thursday) that the PMI in
several European countries and China contracted. Ireland missed growth
targets and central banks around the world continue to print unprecedented
levels of fiat currency as if printing money and creating more debt will
solve a debt problem.
All of these issues are
concerns, but ultimately price is the final arbiter in the world of
flickering ticks. From these eyes there are two possible outcomes for the
price action in the S&P 500. The first outcome which I believe is more
likely is a test of the 2011 highs which results in a snap-back rally that
takes us deeper into the 1,420 - 1,440 resistance zone. The chart below
demonstrates the bullish potential outcome.
SPX Bullish Outcome
Price action at some point
will backtest the 2011 highs and the reaction at that point will be critical.
Generally speaking price action does not break a key support or resistance
level on the first attempt. Usually the 2nd or 3rd attempt will result in a
break of a key support / resistance level.
In this case, a test in coming
days would likely result in a bounce and reversion to the previous trend. A
possible, albeit unlikely outcome would be a break below the 2011 support
zone which would then come close to triggering a trend change. The daily
chart below demonstrates the bearish potential outcome.
SPX Bearish Outcome
I do firmly believe that the
U.S. Dollar Index will hold clues about the future for the price action of
equities. According to cycle analysis, the Dollar should come into is daily
cycle low sometime in the next few weeks, if not sooner.
From that low, we should see
another move higher for the Dollar Index which I anticipate will test the
recent highs near 81. The daily chart of the U.S. Dollar Index futures is
shown below.
U.S. Dollar Index Futures Daily Chart
If my expectations are
somewhat accurate, the short term weakness in the Dollar will assist stocks
and risk assets in a move above recent highs. In the case of the S&P 500,
a move to key resistance at 1,420 - 1,450 could occur.
Readers should keep in mind
that weakness could be disguised as just a consolidation near the 20 period
moving average which has occurred in the past when analyzing the Dollar Index.
However, I would not rule out one more leg lower before the Dollar finds a
bottom.
Gold, silver, and the miners
have been under selling pressure for some time and are likely due for a
bounce to the upside. The weakness in the Dollar discussed above would allow
precious metals and miners to work off some of the short term oversold
conditions that we are seeing presently. The daily chart of gold futures is
shown below.
Gold Futures Daily Chart
After a move higher into or
around the $1,700 / ounce price level for gold, I believe that another leg
lower will be quite likely.
Conclusion
Readers should be mindful that
the 1st Quarter will end on March 30th for financial markets. Window dressing
and portfolio painting are likely to occur next week. I would not be at all
surprised to see the tape painted to the upside during the final week of
March after this brief pullback that we witnessed on Thursday and Friday
morning.
Money managers want to show
off their returns while demonstrating ownership of key names that drove
performance during the quarter such as AAPL. I expect the price action on
Friday and the rest of next week to have relatively light volume and a bias
to the upside.
Barring any major financial
news or geopolitical event, I do not expect to see price action work below
the 2011 highs in the near term. The possibility cannot be totally ruled out,
but it would seemingly be a rare occurrence to see a major support level
break down on the first back test attempt. We may see lower prices early next
week, but if the 2011 highs hold the bulls remain in control in the short
term.
The real question readers
should ask themselves is if prices do extend higher and we reach my target
resistance zone for the S&P 500, will the retail crowd jump in and push
prices higher, or will the banks be trading with each other as a major top
forms? In coming days and weeks we should find out once and for all just who the
real muppets truly are.
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