LunaticTrader

Investing with the Moon

Is the breakout for real?

Posted by Danny on June 9, 2014

Stocks have pushed to new highs in rather convincing fashion. Is this a real breakout, or a just blow-off top?
Here is the current chart for the S&P 500 (click for larger image):

S&P 500

Our lunar red period has not stopped the recent rally and the S&P 500 chart is showing a clear breakout from the recent sideways pattern. This kind of breakouts is usually tested, so I think the market will drop back to 1920, where resistance should have turned into support, before possibly heading higher in the next lunar green period. Meanwhile my technical indicators have dissolved the bearish divergences that plagued the market since the start of the year, and there is now further room to rise based on the long term up trend channel. A drop below 1850 would tell us that this is a false breakout.
We cannot rule out a peak at this point, but on blogs and social networks I don’t see the kind euphoria that normally comes with major tops. Rather on the contrary, I see massive disbelief, cynicism and even anger about this stock market’s continued climb. Everybody seems to be trying to go short at the top. Comparisons with 1929 or 1987 have been getting extensive coverage in financial news media, implying that we are about to crash. Few and far between are the calls for a continued bull market.

It is one of the great benefits of writing a financial blog or newsletter that the responses (or absence of them) often provides good clues where the market is actually going. For the last couple of years, whenever my analysis or chart points to an impending decline in stocks, it gets comments and likes on twitter. But whenever I post a bullish scenario it just harvests silence. And for gold it has been just the reverse. So, I have gradually learned to doubt my forecast if too many readers agree with it. The scenario that nobody believes is not rarely the one that pans out.

For example, almost nobody is considering the possibility that we are in a repeat of the 1920s, a scenario I have been watching since last year. Since our latest update the odds for this scenario have continued to go up. Here is the updated chart (click for larger image):

Dow vs 1920s

The correlation between “Dow Aug 1921 – Nov 1926” and “Dow Feb 2009 – May 2014” has now climbed to a whopping 90.4%, up from 81% when I first posted this chart. The case has become even more compelling with the news that Q1 US GDP was negative. A mild recession in 1927 also forced the Fed to delay their unwinding of ultra-low rates. When they finally started raising rates in 1928 it caused the stock market to double within 18 months, and then a collapse into the great depression. The Fed is quietly setting us up for a similar disaster, simply repeating their mistakes from the 1920s.
One of the conditions to keep this scenario on the table was that the Dow needs to break out above 17000 this year. We are now very close to that point. I still think the market will deviate from the 1920s at some point. But the question is: when? Keeping up with the roaring twenties would give us Dow 20000 by early 2015, with the market spinning out of control after that. If so, I would expect to start getting comments and likes for bullish posts, while harvesting silence for bearish scenarios. That’s how we will eventually know when we are close to the top.

Good luck,

Danny

 

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8 Responses to “Is the breakout for real?”

  1. despe906 said

    Pure wisdom, Danny, you don’t expect to be popular among those you take the money from. I personally feel uneasy when someone agrees with me. That 20’s scenario is probably more likely than a new bear right now;)

    • Danny said

      Thanks for commenting.
      Just saw an article indicating that investors are making big bets to the downside once again: http://finance.yahoo.com/news/shorts-reload-p-500-ritual-230132895.html
      It doesn’t guarantee they will be wrong, but based on past observations the odds are against them. I don’t think the 20s scenario will play out exactly. But of course, the longer we continue along that trail the more likely we will end up with something similar and with similar fall-out in the next 10 years. And that’s not an attractive prospect.
      But maybe it is just an inevitable step. In the 1930s a lot of agricultural jobs disappeared, and the 2020s may mark the end of factory jobs. A major transition that comes with a major crisis/adjustment.

      Danny

      • despe906 said

        I think there is a lot of political changes to come. Euro may go, E.U may break up, unrest and separatist movements in the U.S. will come to the surface as the dollar ceases to be the reserve currency. Also the Great Depression lead to WW2 and lots of changes. The whole monetary system may be revised. A lot of things now look ugly, so for most fundamental traders/investors it’s not an easy market. A fundamental trader looking at the history will end up shorting the bull. I am glad that at this point of my trading fundamental ‘truths’ leave me unimpressed, I simply don’t care. This market looks like it’s being bought up, which means : there is more to come. The bearishness among retail participants is a confirmation.

  2. Benjamin said

    Danny
    Your article states “A mild recession in 1927 also forced Fed to delay their unwinding of ultra low rates. When they finally started raising rates in 1928, it caused the stock market to double within 18 months, and then a collapse into the great depression.” Please explain how raising the rates caused stock market to go higher when such action should cause the market to go lower because people would be investing in interest financial instruments instead of the market.
    Benjamin

    • Danny said

      Hi Benjamin,
      When interest rates go up, prices of bonds go down. The longer the maturity, the more they go down. So, when the Fed *starts* raising rates, do you want to buy bonds right then and there? Or would you rather wait until the Fed is (nearly) done raising rates?
      Buying bonds when rates are starting to go up is like signing up for a guaranteed loss in the first year(s). Why would you do that? Even putting your cash in the mattress for a year would be a better idea.

      So, when the Fed starts raising rates it will first drive retail investor’s money out of long term bonds, and some of that money will find its way into stocks. And then at some point, when rates are attractive enough and stocks look really overvalued, then a sudden move in the other direction starts: stocks are being sold and the money flows into bonds (that perhaps yield 5 or 6% by then vs 2 or 3% right now).

      E.g. look at 2005. The Fed funds rate started to go up. But that didn’t drive stocks prices down, on the contrary. Then 2007, when it looked like Fed was done raising rates, that was a good time to lock in those high rates by buying bonds. So stocks were sold and the money flowed into bonds. Notice that the crash didn’t start when the Fed started raising rates, the crash didn’t start until they were done raising rates. Same happened in 1986-87 for example. It is not always like that, because other factors can come into play, but it is a very common scenario.

      The people who sell/short stocks when the Fed starts raising rates in 2015 will probably be very surprised to see stocks go up instead of down. And it is that short covering rally that can create an explosive move upwards like in 1929, followed by an implosion. Fed will try to avoid that scenario by raising rates very gradually, but that may not succeed to avoid the catastrophe of a massive stock bubble.

      Danny

  3. […] * Bonds (TLT) have been going down. A weekly close below 109.13 would be the answer. Some of the money that comes out of bonds is likely to move into stocks. When that happens we will enter the bullish final stage of the 1920′s scene and its time to SELL! […]

  4. sanchan said

    Is this the last post about the 1929 market crash correlation?

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