The markets can’t stay in Wonderland forever

It was hard to ignore the news that the Dow has just made an all-time high.

It is getting regular headlines in the financial media and even features prominently on BBC radio news. Curiously, the domestic FTSE is hardly mentioned compared with the Dow.

So now that this market development has become common knowledge, are we finally near the top?

Since the start of the year, many pundits have called for a correction – but none has been forthcoming. That much was reasonably predictable. After all, when an expectation is widely held, it rarely occurs. 

A perverse habit of the markets

Remember the ‘collapse of the euro’ motif in recent months as it rallied to the 1.37 area from the 1.20 low last summer? The blogosphere was full of disaster predictions. All the while, as the ‘euro is doomed’ chorus played out, the euro was strengthening. What a surprise!

That is one of the perverse habits of markets – and one which traders of all types are advised to monitor because tradeable information lurks within.

This behaviour goes hand-in-hand with the idea that sentiment drives markets, of course.

And I advise all traders to keep a watchful eye on sentiment – especially when it becomes extreme. And that means monitoring the media as well.

And that brings me back to the current situation in the Dow.

All the while, as many were expecting a correction, it failed to materialise.  Markets rarely do what the majority believes.

But now, I detect a lessening of this worry – I see fewer articles calling for a downturn. Instead, many are making higher projections.

So now, I am looking out for signs of a top. Will I see one soon?

Two clues to see if the market will top

On Monday, I had a target in the 14,340 region, and that has been hit and now exceeded by around 50 pips as I write.

So how does the picture look this morning?

To help, here are the hourly tramlines I have been working of late:

Dow Jones spread betting chart

(Click on the chart for a larger version)

The lower line sports many touch points – including the nasty head fake of last Friday.

The upper line has the good prior pivot point (PPP), but only a couple of decent touch points.

What to make of this?

Let’s zoom in some more to see a terrific development:

Dow Jones spread betting chart

(Click on the chart for a larger version)

I am able to draw a centre tramline, which has many good touch points, and which the market has been trading above since Tuesday.

Note that for some time, momentum has been weakening. This is a critical sign that the top may be at hand.

Meanwhile, the market seems to be heading towards the upper tramline in the 14,450 – 14,500 area.

What will give me a clue that market has turned?

The first clue will be a break of the centre tramline, and the second clue would be a break of the lower tramline.

But are the conditions ripe for a turn here?

Remember, I want to see an extreme in sentiment, and one measure is the commitments of traders (COT) data. Here is the latest data as of 26 February:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
($5 X DJIA index) Open interest: 124,271
Commitments
41,708 10,844 591 60,488 96,326 102,787 107,761 21,484 16,510
Changes from 19/02/13 (Change in open interest: 664)
3,701 265 411 -3,930 -1,148 182 -472 482 1,136
Percent of open interest for each category of traders
33.6 8.7 0.5 48.7 77.5 82.7 86.7 17.3 13.3
Number of traders in each category (Total traders: 114)
38 19 5 38 29 77 52

The non-commercials – mainly hedge funds, who are primarily trend-followers – are massively long, and even added to long positions in that week.

That is clue number one.

And here are a few more:

• Trading volumes have been weak on the rally, showing less conviction.
• The sell/buy ratio of company insiders is at a record high – do they know something the hedgies don’t?
• Bullish consensus data from all of the major polling firms point to record or near-record bullishness, and levels seen previously where major turns occurred.

At times such as these, where is the buying coming from that is making the new highs?

It is from fresh buying and short-covering of the amazed bears.

The markets have to wake up soon

Remember, the stock market is running on liquidity, and the bulls expect the Fed to keep the pumps working overtime forever.

But is this a realistic expectation? The Fed has promised to maintain the quantitative easing (QE) operations until unemployment has declined to 6.5%. While the prospect of reaching this goal remains slim, at least in the short-term, the view is that the Fed should keep supporting stocks.

What a perverse result! A weakening economy translates into higher stocks.

Earlier today, the closely-watched US employment data was released for February, showing US unemployment at its lowest level since December 2008. Let’s watch closely to see how the markets will react.

But this Alice in Wonderland situation will not be maintained for ever, and at some point, the market will see that long bond yields are rising – contrary to the Fed’s wishes – and that the Fed is not the all-powerful driver of the economy and stocks.

And when the market wakes up, the result should be historic.

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

The essentials of tramline trading

Advanced tramline trading

An introduction to Elliott wave theory

Advanced trading with Elliott waves

Trading with Fibonacci levels

Trading with ‘momentum’

Putting it all together

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6 Responses

  1. 08/03/2013, tradermanic wrote

    Great articles , very informative and enjoyable.

    Imo the markets are being driven by inflation.

    Traders, investers and punters are looking for what they perceive is a safer haven for their cash, the value of which is constantly diminishing.

  2. 08/03/2013, Kevin wrote

    In todays report you say that

    On Monday, I had a target in the 14,340 region.

    Well I didn’t see it!
    My Monday Money Week Trader states:

    Unless proven otherwise , the market has completed its four-year ascent to my long-term target of 14,136.

    Regards

  3. 08/03/2013, Bronco Bill wrote

    I agree with all you said John about the Dow. However, the S&P 500 may be the one to watch as it is now only 25 points below the 1576 high made on 8th Oct’ 2007 and is now 25 points higher than the top made in 2000.
    Could this be a massive “triple” top in the making ? I dont know, but what ever happens the Dow the FTSE’s will all follow suit and I would guess it will all end in tears again.
    Also you said that ” Markets rarely do what the majority believes”. I’ve often given that some thought when I hear and read that many believe that low interest rates are going to remain for a least the next four years.

  4. 10/03/2013, Bronco Bill wrote

    Another interesting thing to note about the S&P (well to me anyway) is that in October last year the 50 month MA nearly crossed the 200 MA with only 4 points between them.
    The rally since then has pulled the averages apart again slightly. If the markets do turn with a vengeance within the next few months as I suspect this will cause a “death cross” to occure where the MA50 crosses to below the MA200.
    The last time this happened was in 1939….coincidence? I hope so.

  5. 12/03/2013, norman wrote

    I’m thinking we have reached a position where there is no one genuinely buying, so the only buy orders in the system are (shorts’ stops) racked up just above each fresh new high hit. as a reult even though no one wants to buy, this creates a self fulfilling upward spiral.

  6. 14/03/2013, Darran wrote

    The centre tramline has been breached and we are currently bumping along the lower tramline so there are some interesting times ahead!! Not sure if I would go for a straight short here as recent times have given a lot of weight to the ‘greater fool’ theory but some kind of put option is starting to look very attractive

Commenting on this article closed

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