Tonight I'm going to take a different approach and make arguments that support the bear case in the short term. There's been no change with the Rydex stats tonight. As mentioned yesterday, 2 out of the 3 Rydex indicators are flashing a strong buy signal but the 3rd and most important one is still holding out. If that one ends up giving the green light as well and market action starts to improve (which it hasn't due to relative weakness in tech and weakness in bonds), I will become aggressively bullish. Until then I'm doing a whole lot of nothing and I'll continue to do so for as long as it takes. Anyhow...the bear case as promised.....
Unlike what happened last Thursday, today's gap crapped. Were there any clues that this was going to happen? I hate to sound like a broken record but tech was relatively weaker although not by a huge amount but emerging markets were strong (I consider the action in tech however more important). Bonds also broke down to a new ST low. I've been comparing this period to the June-July slide. At the low of that correction, it coincided with a strong move in bonds. TLT for example gained 10% from the time equities rolled over in mid June to their low point in early July.
In fact, if you look at every ST low since the March bottom you will see that bonds had been showing some sort of strength. Given that bonds have made a NEW LOW despite the fact equities have rolled over already, strongly suggests further weakness in equities lies ahead.
We also see the market ignoring good news. This could be an indication of bad news coming down the pipe or that the market has priced in all the good news for now. The burden of proof lies with the bulls now.
The behavior of the option market is also bearish. Sure, we have seen quite a spike in the VIX but look at how quickly it comes down on just any hint of strength. For example, over the last 2 days the SPX is up a modest 6 points yet the VIX has dropped 10%. That signals complacency. Option traders have demonstrated a spike in bearishness coinciding with the market dropping 6% but they have also been quick to flip back to buying calls aggressively on any strength once again signaling complacency.
Although 2 out of 3 Rydex indicators are showing strong buy signals the 3rd and most important indicator is NOT. Besides, the rydex data is the only one set of indicators giving a buy signal overall. Other clues such as market action, the behavior of the vix and option traders are not confirming and therefore the rydex data could very well be giving a false signal.
So there you have it...the ST bear case. You have to admit, there's some good points here, namely the behavior of bonds. Take a look at every ST low we've seen....mid May, early July, Sept 1, Oct 1...all coincided with bonds being strong for at least 1week prior. This confirms my notion that any rally we see will be ST only and a retest or lower low lies ahead. I'm not sure if today we saw the end of the ST rally…it’s a coin flip if you ask me. The next couple of days could bring fireworks in either direction due to the employment data to be released.
Truth be told, I believe the lower low scenario looks like it will play out eventually so be prepared for it. It's by no means a lay up on the short side given the rydex data. It's a mixed bag and in these situations I tend to just watch the action and wait for dust to settle. I may attempt a short side trade if there's a good set up but if in doubt I'll just watch the action.
All in all, I believe the bears have the upper hand in the ST even if the market manages to rally for a day or 2 unless of course we start seeing the negative action of bonds, tech and option data do an about face.
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