[Updated with Expanding Charts]
We hit it out of the park with Friday’s trades in the unique circumstance where the major indices tagged important demand levels while the crowd was overly fearful and short on the session. As suspected, the shorts panicked into the close giving us a 50 point rally from our entry point on the S&P 500. The IWM (small company ETF) and the QQQ (Nasdaq 100) delivered similar, positive results. Again, the circumstances were unique for trades with very low risks to stop.
There is yet nothing to indicate that the equity markets are out of the woods. However, as long as the S&P 500 Index stays above the current demand line marked on the S&P 500 futures chart above, the intermediate bull market channel is intact even though it is a rough ride of late.
This gives us an absolute dividing line to guide us in the weeks ahead. Break it, and we can use time at price from December to calculate a new fair value target for January at 4440. This level is also likely to converge with the rising 200-day line – a logical, new demand area. I would back up the truck on long options should we achieve that level – everything else being equal.
I thought it useful to show you the put/call ratio on Friday in the chart above. It hit a short-term extreme associated with the October and early December lows. This was unusually helpful for Friday’s session.
Traders were pounding on the demand line all day trying to break it, resulting in a lot of traders stuck “short in the hole.” When the market then fails to break the demand line by late Friday afternoon, the shorts tend to run for the exits all at once, fearing a long weekend and Tuesday rally (the U.S. markets are closed on Monday). We saw that panic short-covering materialize about two hours before the close, and it never stopped.
But the CBOE put/call ratio is a very short-term guide – good for a session at best. Note that the 10-day put/call ratio average is still rising (yellow line in the chart above). For intermediate-term confidence, the line should be falling or peaking.
So intermediate investor sentiment is neutral, giving us no edge from a macro perspective. Regardless that we find ourselves in difficult price action, there is no sign of a reliable intermediate low. Investor sentiment would need to deteriorate further, resulting in more negative price action as we move into the 15-week trough next week. In short, we need more fear.
As you can see in the chart below, Smart and Dumb Money Confidence is also at a crossroads. This is additional confirmation that there is not enough negative sentiment to favor cruise control with our trades. We need to manage them closely at the moment. The CBOE put/call ratio can merely help us on a session-to-session basis.
We will work with the current trades using the Navigator Algorithm applied to the hourly charts. For the most part, we will ignore the news and speculative Fed narratives. Below, you can see the trades in Friday’s turn through the index quadrants.
We took the Navigator Algo buy signal on the 15-minute chart for the early entries in Friday’s case. The buy signal then materialized on the hourly charts as it moved across the various time frames in a “W” pattern. Applying the Navigator Algorithms to the hourly charts on the trades will tend to be more responsive than the daily charts with the current volatility. We will let the Algo takes us out when it is ready.
But short-covering is not the same as buying. There is no guarantee the markets will follow through Tuesday, but I suspect they will for a few sessions, especially given Friday’s successful retest of Monday’s low and the reversal candle off the demand line.
The chart above shows the entry on the S&P 500 Index futures 15-minute chart from a longer perspective. Note that the 15-minute candles have moved above the mean. The mean should now provide support, and perhaps an additional entry point if one wants to add to positions. We would use a combination of a mean violation and an algo sell signal on the 15-minute chart to go to a high sell alert status. Ultimately though, the hourly chart sell signal would take us out.
All in all, what Friday’s trough represents is another 20-day cycle low. Clearly, the pattern is loose and exaggerated, which is bearish. This wide, unruly pattern departs from the relentless one-time framing candles we saw even as late as the year-end rally. But the pattern of higher highs and lows remains intact.
Perhaps more important, the intermediate cycle has been running about 14 to 18 weeks, trough to trough, at least since the March 2020 lows. The latest week is the 15th week since the October trough and coincides with Friday’s low. The cycle varies somewhat and the trough could still be in front of us to combine with next Friday’s monthly options expiration to exert a potential negative influence. After that, and depending on where that takes us, I might be inclined to be more bullish and continue to work the rising wedge pattern on the daily chart.
You can expect us to undertake many similar kinds of “trades” as the year ensues. The year ahead has the potential to destroy the latest crop of novice investors, assuming it doesn’t take down long-term investors as well. The Federal Reserve (along with a misguided Democrat administration) has managed to screw up the economy so badly; it will take a miracle and a lot of time to recover from the various distortions. The fear now is that another Fed policy mistake (reversing course too fast) will only make things worse.
Not that I am qualified to be a critic. I don’t even pretend to be an expert on the economy or inflation. In fact, I don’t think I have ever met any such purported expert. I do observe a lot of bloviating. Yet knowing that the Federal Reserve can mess up so badly with more resources than any entity in the world only underscores why I won’t even try to tackle these “theoretical” concepts.
What I do understand is price action. The rest is a bunch of noise and egocentric pontificating. And while others will continue to try to explain everything to you (as if they even know), I will stick to what I know. I intend to make a fortune this year doing so, just as I have these past two years we have worked together. I hope you will join me.
When we can enter and hold on, we will. When we have to trade, we will trade. And when it is not clear, we will stay out.
I am working on a video this weekend that will explain the strategy for the year ahead. I have heard from many of you that my predictions at this time last year were right on the money – and you want more. Yes, I predicted the inflation that arrived and it has even exceeded my expectations. I think a first grader could probably have done the same – given the flood of money supply into individual hands. But it doesn’t really matter, and I would rather have been wrong.
For now, the biggest short-term risk on the table is a Fed policy mistake in the context of an overvalued stock market detached from fundamentals. The Fed correctly perceives that their credibility is at stake, which may cause them to overcompensate. They are, at the end of the day, human and fallible. Any further mistakes could devastate portfolios and retirees. Financial markets are in a delicate state.
It does not help that the Fed’s track record in these matters is abysmal. As Zero Hedge illustrates in the chart below, since 1960, with stock market valuations over 20x earnings, the Fed started long-term rate-hiking campaigns that resulted in three bear markets, two recessions, and at least one debt crisis. The outcomes often led to new credit crises requiring even more bailouts.
That certainly is not an enviable track record. And so the question is, where does this all take us?
It ends with us becoming uberly wealthy by capitalizing on the mistakes and volatility at hand, taking advantage of the new crop of rank amateurs now participating in the financial markets. Remember, either they are taking our money, or we are taking theirs. While that may not help the country, our personal survival is ensured. I don’t know about you, but I have no intention of letting the idiots in charge destroy my wealth. I am too old to start over.
And what about Bitcoin? Unsurprisingly, it has not been a hedge against anything. You can have it – I am not interested.
As the Chinese proverb goes, “Better to be a dog in times of tranquility than a human in times of chaos.” But chaos is profitable. You cannot trade without volatility. There will be plenty of that as the year ensues. Let’s keep our eye on the ball and take full advantage.
A.F. Thornton