Value of Perfect Information

Although I use E-wave as a primary Technical Analysis method in my trading, another major factor in my trading is Tactical Analysis. How I would describe this is that I look at things like the monetary policy backdrop and market sentiment to give me a big picture directional bias. When the Tactical and the Technical line up saying the same thing that provides a strong edge.

Unfortunately right now is not one of those times. My Technical E-wave work looks bearish, but my Tactical Analysis tells me to expect higher prices. For those who are Mortie’s Premium subscribers you get to hear my Technical Analysis on a daily basis so I won’t rehash that here. But, suffice it to say 1090 ES is a major battle line IMO. I call it the “Maginot Line”. So, as long as we are below it I have to give benefit of the doubt to the bearish scenario. But, what I really want to review in this post is my take on the Tactical backdrop.

First let’s start with Monetary Policy. Like it or not (and most Permabears hate it) the Fed is a MAJOR factor in determining the direction of the stock market. So, what did this week’s Fed statement tell us? I won’t reprint the entire statement as those who wish to read it can do so www.federalreserve.gov. But, IMO the money quote is the following:

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

This answers the question everyone was asking about the Fed’s “exit strategy” from the ultra loose monetary policy that has been stoking asset bubbles in just about every risk asset under the sun. The Fed is spelling out the factors that must change in order for them to end the easy money. They are the following:

1) “low rates of resource utilization” – Translation: Unemployment rate must decline.

2) “Subdued inflation trends” – Translation: Core PCE must rises above their 2% comfort zone.

3) “Stable inflation expectations” – Translation: I think the Fed is watching the Long Bond Yield as their benchmark for inflation expectations. They certainly can’t be watching Gold as that would certainly not be signaling stable inflation expectations. So, it would take a significant uprising by the Bond market vigilantes to get the Fed’s  attention.

Out of these 3 criteria, the first 2 are severely lagging indicators, which means if the Fed waits for those signals to tighten policy it will be far too late and they will be well behind the inflation curve. Not to mention that we will have massive bubbles in stocks and commodities and a major collapse in the Dollar. Only criteria number 3 is forward looking, so really the only hope to avoid bubble mania is for the Bond market to revolt. That is why barring a major spike in Bond Yields the liquidity backdrop remains very bullish for stock here IMO. “Don’t Fight the Fed” is a Wall Street truism that has stood the test of time, and right now the Fed wants investors to take risk (ie. bid up stocks). So, to bet on a resumption of the bear market here and now is to bet the Fed will fail. And that is not a high probability bet IME. Of course that argument won’t dissuade the “P3″ cult one bit as they will just parrot the Prechter pablum about “social mood” and say the Fed is powerless. I always get a good laugh from that one as Fed and “powerless” is an Oxymoron as far as I am concerned. How can the entity that controls the creation of money be “powerless”. OK, enough of that rant but you get the picture…

Aside from Monetary Policy the next fly in the bearish ointment is trader/investor sentiment. I keep hearing how there are “too many bulls”. But for there being so many of them they sure are hard to locate . Don’t take my word for it though. Just go peruse a handful of the most popular trader blogs and read through the comments sections. I guarantee you will find a ratio of at least 10 to 1 bears to bulls (and I am being very generous as it really is probably more like 100 to 1). You will see that same thing in recent investor/trader opinion polls like AAII, or following the money by looking at things like Rydex fund flows and small trader options activity. The retail crowd is skeptical and cautious at best and downright frothing at the mouth bearish at worst. And it is amazing how eager everyone is to call THE top and resumption of the bear. If this was indeed THE top then IMO it will certainly go down in history as the most well called top ever. And you will soon see many newly minted millionaires in the comments sections of your favorite blogs as they all cash in on their lottery ticket P3 crash puts. Is it really that easy?

Now, I’ll be the first to admit that if I was just looking at E-wave counts I would strongly consider the mega-bear scenario and at the very least a substantial intermediate-term decline. But, the monetary and sentiment backdrops are not supportive of that scenario right now and that prevents me from getting too “beared up” just yet. Maybe, I will be wrong and it will be different this time. But in my 20 years of trading I have never seen a major top occur with this kind of monetary policy and this kind of widespread bearishness so soon after a top.

The only way I can reconcile the bearish Technical with the bullish Tactical is if we see a major dislocation in the bond market very soon and/or we see retail trader sentiment do a rapid 180 to bullish capitulation. Of those 2 bearish catalysts the former is the more likely IMO and the one to keep and eye out for. So, I will be watching the bond market closely, following all Fed speeches for subtle clues, and of course watching to see if the army of retail bears ever thins it’s ranks. If we can get some of those things to line up then we could be looking at a strong bearish edge. But, for now all I see is mixed signals.

Tags: Smart/dumb money, Technical analysis

Categories: AAII Sentiment Index Ratio ,Commentary ,Exclusive ,Market Sentiment ,Markets ,Smart/dumb money

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