As America’s economy weakens, stocks hit new highs. But this ‘Alice in Wonderland’ situation can’t be maintained for ever, says John C Burford. And when the market wakes up, the result should be historic.
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?
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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?
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
Row 8 - Cell 7
Row 8 - Cell 8
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:
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John is is a British-born lapsed PhD physicist, who previously worked for Nasa on the Mars exploration team. He is a former commodity trading advisor with the US Commodities Futures Trading Commission, and worked in a boutique futures house in California in the 1980s.
He was a partner in one of the first futures newsletter advisory services, based in Washington DC, specialising in pork bellies and currencies. John is primarily a chart-reading trader, having cut his trading teeth in the days before PCs.
As well as his work in the financial world, he has launched, run and sold several 'real' businesses producing 'real' products.
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