The strength of this rally caught a lot of people by surprise including me. Near the market lows in March I was well aware that the market was quite oversold and a snap back rally could occur at any time. But because certain sentiment indicators namely, the put/call ratio (which has been by far the single best indicator since the bear began) were not at extremes I didn't think it would amount to more than a rebound to about 750 on the S&P initially. But I noticed a strange thing....anedotally the tone of the trading community and the media was one of skepticism. The rally was being faded heavily by traders it seemed and labeled just another bear market rally and so the contrarian in me resisted the tempation to short it.
As per the teachings of hedge fund manager Todd Harrison whom I respect, bear market rallies have 3 stages: denial, migration (cautious optimism) and panick (fear of being left behind). Up to the rise of 750 on the S&P it seemed like were still at stage 1 but as the market climbed to 800 and above we reached stage 2 and now I believe, based upon the change in sentiment I'm observing, we are at or near the begining of stage 3. Bears are running scared now and just like in late November-early December a lot of them are now calling for the S&P to hit 1000. When bears start running scared like this, you know the rally is near its end because they are the last ones to be convinced of it.
But there's still a lot of trapped bears out there who have loaded up on FAZ and SRS sitting on big losses. Most of these guys I bet missed the boat on a lot of the big gains FAZ and SRS made earlier in the year and when these ETFs crashed these Johnny-come-lately types figured these things were a no brainer to "buy on the dip". These guys are now trapped in triangle choke hold and judging by what I read on the message boards a lot of these guys are just about ready to tap out some of which I'm sure already did, but I still think there is some more bear capituation needed for this rally to end for good.
Everyone is eyeing 850 on the S&P. If we close above that it would constitute a "breakout" according to the legions of technicians that are out there. This event would surely lead to any hold out bears throwing in the towel fearing that 1000 on the S&P is inevidable. This capitulation would lead to the climax of the panick stage of the bear rally and would make a fantastic medium term shorting opportunity which I intend to take full advantage of. Obviously a lot of what I just said is pure conjecture and we are certaintly overbought enough now to see a wicked decline. However, my experience/intuition is saying "not yet" with respect to hitting the short button on a longer term basis. If I'm wrong and we already made the top then I will have no problem joining the bears on the way down but I will try to do it smartly. Chasing gap downs in the context of an uptrend is usually not wise unless your holding period is 1-3 days.
The action we are seeing today looks more like profit taking rather than a rollover from an intermediate term top.
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