Stockmarkets rally, just as I forecast

The sharp rally in stocks caught the pundits by surprise, says John C Burford. But chart-following traders saw it coming.

Stockmarkets rallied hard on Friday following the Bank of Japan's (BOJ) desperate move to implement negative interest rates. This followed European Central Bank boss Mario Draghi's equally hopeful last throw of the dice in December to force EU headline consumer inflation up off the zero line.

The central banks' obsession with their 2% target has always been something of a mystery to me. When consumers are finally enjoying stable (and lower, in the case of energy) prices, why would anyone want to increase them again, given that wages and salaries remain stable? Of course, I do see why. It is because they want asset prices to be keptelevated. After all, central banks have gorged on bond buying and do not want to see their values plummet.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

The stated 2% target is simply a red herring (which many pundits still take seriously). And in true knee-jerk fashion, stocks rallied hard.

But I flagged this move beforehand.

Advertisement
Advertisement - Article continues below

In my postof last Wednesday, I supported my forecast for an imminent rally by invoking a classic example of the 'magazine cover indicator' (MCI) from Investors Chronicle: "Spotting sell signals how to profit from short selling".Remember, the MCI is a contrary indicator and indicates a probablechange in trend.

In fact, that wasn't the only example I found in recent days. As I scanned the media I found several more prominent articles explaining how to short stocks. To me, that indicated I was on the right track, bolstered as I was by my chart-reading analysis.

This is what I wrote on Wednesday: "Now their readership is short selling, this is the ideal time for a huge rally to take them out. The market's cruelty is almost beautiful to observe." And the market delivered right on cue.

Confirming the bearish sentiment among financial journalists, I mentioned that the Daily Sentiment Index (DSI) on the S&P 500 index has recently plunged to fewer than 10% bulls.

With this overwhelming bearish tone, the market was ripe for a huge counter-trend rally to take out many of the recent shorts.

Having prepared myself for this anticipated rally phase (and having taken partial profits on my shorts earlier), my task now is to identify its top. Because if I can do that successfully, I will have another great short trade working.

Advertisement
Advertisement - Article continues below

Let's look at the daily S&P chart with my Elliott wave labels:

16-2-1-MWT-1

It closely resembles the Dow chart I captured before the big Friday up day:

16-2-1-MWT-2

Here, my blue tramlines are a little more convincing. But the theme remains the same the rally should terminate in the area marked (or below).

In the S&P chart, I have a complete five down with a momentum divergence at the wave 5 low. Now the market is making an A-B-C relief rally and currently, is putting in the C wave.

And if I am right, the market is getting teed up for another huge leg down.

Time to take a step back and look at the bigger picture. Here is the Dow chart showing the May 2015 all-time high:

16-2-1-MWT-3

When enough shorts have been squeezed, the market should make its wave 4 high and resume its decline.

Advertisement
Advertisement - Article continues below

But the key level to watch is the pink area. If the market can break solidly below that, it would confirm the first five down (small red) to show the main trend really is down.

But there is another possibility (there always is!) and it is this: if the market does not violate that key area and moves higher to above the 17,000 level, the bear will be forced back into his cave. And the all-time high of 18,365 would be in danger of being exceeded.

I have maintained the view that during this bear market, small caps will be weaker than the Dow and S&P large caps as riskier stocks will be shunned in favour of the 'safe' large caps. Here is the Russell 2000 index of small caps:

16-2-1-MWT-4

The current rally has hit the Fibonacci 38% level, way short of the near-50% level reached by the S&P. To me, that indicates that in the next bear phase, the small caps will lead the way again.

It is a little-known fact that whenever the Fed announced its various QE (quantitative easing) and ZIRP (zero interest rate policy) schemes since 2008, the US stockmarket made a significant high and sold off. It was the classic 'buy the rumour, sell the news' result. Will history repeat for the BOJ?

It would be a good time to do it here is the Nikkei 225 hourly chart:

16-2-1-MWT-5

There is a lovely A-B-C rally right to the Fibonacci 50% level. Could this be it?

Advertisement

Recommended

Visit/trading/spread-betting/600852/build-profits-with-this-industrial-equipment-rentals-company
Spread betting

Build profits with this industrial equipment rentals company

United Rentals is poised to benefit from higher spending on infrastructure. Matthew Partridge explains the best way to play it.
26 Feb 2020
Visit/trading/spread-betting/600782/boeings-share-price-plummets-heres-how-to-play-it
Spread betting

Boeing's share price plummets: here's how to play it

Boeing shares have fallen by a third this year. But there could be worse to come. Matthew Partridge explains how traders should play it
10 Feb 2020
Visit/519524/how-my-2019-spreadbetting-tips-fared
Share tips

How my 2019 spreadbetting tips fared

Matthew Partridge reviews performance of his 2019 spreadbetting tips. This year’s winners include Bellway, JD Sports and Taylor Wimpey.
17 Dec 2019
Visit/519285/bettingon-politics-some-safe-labour-bets
Spread betting

Betting on politics: some safe Labour bets

Matthew Partridge outlines a few flutters on what should be safe Labour seats in the general election.
10 Dec 2019

Most Popular

Visit/investments/stockmarkets/600909/will-coronavirus-kill-off-the-bull-market
Stockmarkets

Will coronavirus kill off the bull market?

It seems clear now the coronavirus will at some point go global. And when it does, will it bring down the stockmarket’s bull market? John Stepek looks…
27 Feb 2020
Visit/investments/commodities/gold/600887/gold-price-coronavirus-cost-of-face-masks
Gold

Gold, coronavirus, and the high cost of face masks in northern Italy

The price of gold is spiking – as it always does in a global panic. But this bull market predates the coronavirus epidemic, says Dominic Frisby, and w…
26 Feb 2020
Visit/investments/stockmarkets/600910/what-to-look-out-for-as-panic-over-coronavirus-spreads
Stockmarkets

What to look out for as panic over coronavirus spreads

Markets have started to get properly worried about the coronavirus outbreak. And it’s not just stocks, says John Stepek. Here’s what you should be kee…
28 Feb 2020
Visit/investments/commodities/600729/the-rare-earth-metal-that-wont-be-a-secret-for-long
Sponsored

The rare earth metal that won't be a secret for long

SPONSORED CONTENT – You can’t keep a good thing hidden forever; now is the time to consider Pensana Rare Earths and the rare earth metals NdPr.
31 Jan 2020