Better Trader

The stock market and the economy are driven by sentiment

Last week we closed our short on FTSE 100. The index rallied again and we went short again, we closed the trade today and took 187 pts profit. I closed the trade because I am not sure what the S&P 500 will do next.

Not all the indicators are in a perfect position for the market to decline. The main concern for the bears is positive sentiment (rising BTI). We follow sentiment and we try to trade in the direction of sentiment. However there are times when we will go short when sentiment is bullish. This happens at the end of an Elliott wave up, in general sentiment is bullish at the end of a wave up.

But markets are not perfect, sometimes not all indicators are in the perfect position yet the market will decline as it happened on 23rd January.

The BTI is a good indicator of sentiment and right now it is bullish. I believe the time to sell the S&P 500 will come when the BTI turns bearish, this could happen at any time. Indeed the S&P is very much driven by sentiment, when people are in positive mood they follow the Fed. When they are in negative mood they follow the economy. For example on 16 March the Fed cut rates and announced $700bn stimulus package but the mood negative at the time and the S&P collapsed.

Right now the mood is positive that is why the markets could rally further, until the mood changes.... The other thing about positive sentiment is that people focus on the good news (they are optimistic about the future). Because they are in positive mood they believe the economy will recover quickly. History however tells us otherwise. The only way the economy will recover quickly is if scientists find a vaccine for Covid-19. Think about it, how can the economy recover fully with social distancing in place? Many businesses will never operate a full capacity, bars, restaurant, cinemas, airliners....will be half full. And what is the probability of finding a vaccine? Low. As Niall Fergusson writes in the Sunday Times "Do we have a vaccine for Malaria? No, Tuberculosis? No, HIV-Aids? No".

It could take years to find a vaccine, yet the Stock market is rallying on hope. One of the greater investors is Warren Buffet, he is a smart guy, he is worth billions of dollars. why did he sell all his shares in Airlines? Because he knows Airlines will not recover, it will take years before they and other businesses recover.

The Fed can print unlimited amount of money this will not help demand for products and services which is what matters to companies. And if companies don't do well, earnings will drive the stock market down. The excess money in the system will simply produce inflation, slow growth and rising inflation which is called stagflation. Because when the economy goes down, production falls but demand does not fall in proportion because people still get paid by the government so they continue to spend. Either the government stops paying people and the economy suffers more, or they continue to pay people and inflation rises sharply and people are not better off. There is no quick fix.

 

So I think following the Fed is a mistake. It may work in the short term when sentiment is positive but when sentiment is negative people will focus on the economy and the stock market will collapse. Elliott wave says another leg down is coming. But this could happen after another rally because it is a second wave and sentiment is positive.

Elliott wave says that at the end of the second wave of a new bear market optimism will be as high as it was at the end of the previous bull market. Optimism is high when the 34-day BTI is above 400, right now it is above that level. On the chart above a rise above the red horizontal line is overbought. So I think we will get a multi-week decline soon, probably after sentiment has turned negative.

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Today's FTSE 100 trading range

After the Italian referendum, attention will turn to the banking sector where Italian banks are vulnerable. Many Italian banks have never recovered from the last financial crisis, they are trading at multi-year lows and they are struggling with bad debts. They are in need of refinancing but the uncertainty caused by the no vote will make it more difficult to raise finance.

If Italian banks collapse this will affect banks in the UK and the US. Nevertheless, UK banks were firmer yesterday, an indication that the market is resilient in the face of the no vote. In a scenario similar to Brexit, the market has brushed aside bad news, this tells me that sentiment is changing to bullish. Bullish sentiment would make sense at this time of the year, seasonal influence is positive, yet the wave count does not agree with an immediate rally. Wave counts both in the US and UK suggest more downside before the rally starts.

Sometimes the market discounts bad news and rallies after the event. We could be in that situation. Last week decline occurred on fear of a no vote, now the referendum is over people moved back into position. Yesterday’s rally to 6799.5 carried higher than expected but this is a normal move because it’s a second wave and second waves retrace a large portion of the first wave. Today we have support near 6680. The FTSE should trade in the range 6680-6760.

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e-Yield Indicators

 

Last week I mentioned some useful indicators to target the end of a move. The FTSE 100 overbought / oversold condition can be measured with three indicators: 34-day BTI, 13-day BTI and Top 20 Differential. These are my proprietary indicators and they are all reliable.

Difference between the three indicators

Basically 13-day BTI and Top 20 Differential warn of a short term move lasting a few days. The 34-day BTI warns of a move lasting longer (more than 2 weeks). The other difference is that the 34-day BTI is not considered a timing indicator because the expected move may not start immediately. Indeed, there have been some occasions where it took one or two months before the move started. People who use the 34-day BTI for timing will use a wide stop loss, if the expected move does not start immediately you need to give the market room to move. The advantage of being short when this indicator has given a signal is 1) a decline is nearly guaranteed, 2) the profit will be large. As the move will unfold over a long period of time (more than two weeks), normally the profit will be significant if you are on the right side. So you may get into the move a bit early with the 34-day BTI but the reward is huge.
34-day BTI vs FTSE 100

Here is the chart of 34-day BTI since April 2013, with the FTSE 100 as overlay (solid dark line). Each time the 34-day BTI rises above 400 the FTSE 100 becomes overbought and each time a decline follows.

Key dates when 34-day BTI rose above 400

22 May 2013: the decline in the FTSE 100 started immediately, the index lost nearly 11% in a month.
19 November 2013: the decline was already underway, the FTSE lost 4% in nearly a month.
19 May 2014: the decline started ten days later, the FTSE lost 4.5% in two months.
10 February 2015: the decline started two months later and the FTSE lost 17% in four months.
23 October 2015: the decline started immediately, the FTSE lost 14% in less than four months.
21 July 2016: it's been a month since the indicator rose above 400, a significant decline has yet to materialise.

Of course I trade short term so when a decline is underway I will not sit on a trade for months. I will use the other indicators, 13-day BTI and Top 20 Differential, to take profits when these indicators become oversold. For example if I am short based on the 34-day BTI and the 13-day BTI becomes oversold, I will close my short and wait for a bounce before going short again. That was the right approach during the decline from October 2015 to February 2016. There were huge rallies during the decline and going in and out was the right thing to do.

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e-Yield Sentiment Indicator

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This indicator is used to forecast the short term direction of the FTSE 100 and S&P 500.

Video: Thierry Laduguie On Sentiment Indicators

Direct from the Queen Elizabeth Conference Centre a video featuring a UK Investor Show 2014 presentation by Thierry Laduguie on Sentiment Indicators

via www.shareprophets.advfn.com

What One Big Bear Has Been Waiting For

Most investors are complacent -- they do not want to hear what bears have to say.

Not You!

You know the value of seeing both sides of the big picture. And maybe you are already wondering how much higher this rally can climb.

Today we have an eye-opening report for you from Elliott Wave International.

U.S. stocks have been bouncing off of their mid-April fall into negative territory for the year.

No major move goes uncorrected; snapback rebounds are typical after such violent swings.

Numerous technical conditions, however, have aligned to extremes that have never been seen before.

The market's internals are sending warning signs that a major shake-up in U.S. stocks is on the horizon.

Sentiment is pressed to one record extreme after another. Nominal valuations are exploding off of our charts. Stocks priced in any real measure of value, such as a basket of commodities, gold or the U.S. Personal Consumption Expenditures Index (the Federal Reserve's preferred method of measuring inflation) -- ALL show sweeping declines since 1999, revealing a hidden yet very real and ongoing bear market in terms of purchasing power.

Dow shares priced in gold are down a whopping 70%!

Cracks are wider than ever in the mood behind the markets. What's more, U.S. stocks just sent an eye-opening signal that something has shifted, and nominal values (not adjusted for inflation) may soon play catch-up to real values (what you can actually buy with your Dow shares) -- as they always have throughout history.

Elliott Wave Financial Forecast Editor Steve Hochberg wrote in a special BULLETIN on April 10 about an important early-warning signal he has been waiting for.

    We anticipated that the next wave down would be accompanied by even stronger selling intensity, and today's decline fits this view. The NYSE advance/decline ratio was negative by a 3.5-to-1 margin, which is the strongest downside breadth of the nascent sell-off. NYSE down volume was 88.2% of total volume. The S&P's wave ii (circle) high occurred at 1872.53, the Dow's at 16,456.10 and the NASDAQ's countertrend rally ended at 4185.10. … Today's decline was coordinated, with the three main stock indexes confirming each other's sell-off. By day's end, all the major stock indexes are now down for year.

    Short Term Update BULLETIN, April 10, 2014

It remains to be seen whether the April sell-off proves to be what Hochberg has been waiting for, in terms of his big-picture outlook, but now is an excellent time to get up to speed -- just in case.

Because IF this is indeed what he's been waiting for, you WILL want to be along for the ride -- not left behind.

Much of EWI's research shows FAR greater extremes than April's sell-off. It's some of the most refreshing, myth-busting -- and sometimes downright scary -- market analysis you will read anywhere.

Now that it's spring, and the bears have awoken and are stirring in the markets, it's a great time to check in on EWI's somewhat unconventional view.

You can now read EWI's annual State of the U.S. Markets Report, an in-depth, 24-page overview of EWI's long-term outlook on U.S. stocks, the economy, bonds, gold, silver and more. It is free to download, print and read at your leisure.

But you must act now to get your copy of this timely report -- before it is too late to avoid the dangerous risks and to catch and ride the lucrative opportunities EWI sees on the horizon.

This is an extraordinary time to be an investor. The risks are great, but if you know what you're doing, the opportunities can be greater.

When trends change, opportunity happens fast. You have to be ready. EWI's report will help.

Click here to get the free report sent to you now

Magazine Cover Says Sell Housebuilders

The Investors Chronicle published a bullish article on housebuilders last week, the fact that the story appeared on the cover of the magazine is bearish. The magazine cover is a contrarian indicator, when a bullish story makes it to the front cover all the good news is priced in.

 

 

The headline "Why housebuilding shares will continue to climb" should be interpreted as "sell housebuilding shares"

Already some well known housebuilders are falling. Persimmon (PSN) completed a head and shoulders pattern which is a bearish pattern. The stock declined to the 200-day moving average and as you would expect, the bulls came to the rescue. But for how long?

 

FTSE 100 Trading: Which Way This Week?

When the stock market makes a new all time high it is never immediately bearish. The S&P 500 made a new all time high yesterday but not the FTSE 100. The FTSE has probably turned down, I don't think it will make a new high. But the action in the S&P is bullish in the short term, as a result there is a chance sentiment will turn bullish.

 

Despite all this there are many potential pitfalls ahead in particular from Crimea. The stock market has rallied because the tension in this part of the world has eased but this does not mean the crisis is over and in China corporate defaults should intensify with the global slowdown as the Fed taper its asset purchases.

Given the economic outlook in emerging markets and the potential impact that sanctions could have on Russia, and the fact that the Eurozone outlook is the weakest of all after many years of money printing, it is difficult to be positive going forward. Latest PPI numbers for the Eurozone show annual PPI inflation down 1.7%. 

For these reasons I believe that the bull market will come to an end and right now the best market to analyse for direction is the FTSE. Unlike the S&P, the FTSE is far away from its all time high, something you would not expect to see if we were in a bull market. Indices do not always make a new high at the same time but in a bull market they tend to move closely together. This is not happening, the FTSE is telling us that troubles are brewing and this is why the UK index failed to break above its January high and declined in five waves to form wave i (circle).

The rally from the bottom of wave i (circle) is weak and choppy, which is the signature of a counter trend rally [wave ii (circle)]. The internal structure could be triple zigzag in which case the rally is nearing an end.

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FTSE 100 Trading: Which Way This Week?

The ESI (e-Yield Sentiment Indicator) measures market sentiment. Right now it is bearish which means, with the FTSE 100 still trading near the recent low, there is a chance the low at 6492 will be broken. This is the main risk especially if relations between Russia and the West deteriorate further.

But downside is limited, the FTSE 100 is already down 5% from its February high, prices are below the 200-day moving average and the timing indicator, 13-day BTI, is near oversold. Check the 13-day BTI on the following chart:

 

When the 13-day BTI is below -400 the FTSE is oversold and likely to bounce back. The indicator dropped below -400 last week but today the 13-day BTI is no longer below -400. It appears that a rally is underway. This is supported by the position of the S&P 500.

The S&P is still in a clear uptrend, the US index should rally, therefore there is potential for a rally here in the UK in the short term. Given the problems between the West and Russia and the bearish sentiment it is possible that the stock market is entering a new phase, one in which the stock market will go sideways or down in the long term.

In the short term I still expect a rally but it won't be back to new highs, the rally will be a counter trend move with limited upside because sentiment is still bearish.

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FTSE 100 Trading: Which Way Today?

 

 

On 21st February the 13-day BTI was overbought and the FTSE 100 declined. Now we have the opposite situation. The two timing indicators, Top 20 Differential and 13-day BTI became oversold last week and the FTSE is now rallying.When these timing indicators are oversold the odds of a short term rally increase. This is supported by the position of the Directional Movement index at the bottom of the chart and the fact that prices are below the 200-day moving average. Each time the blue line drops below 13 the FTSE starts to rally. Based on the wave count the trend is up, the FTSE should rally to new highs over the next two or three weeks. This scenario calling for a rally to new highs will only gain credibility when the ESI turns turns bullish. Right now the ESI is bearish.

I can't be sure if the trend is up or down because the e-Yield Sentiment Indicator (ESI) is bearish. When sentiment is bearish the odds favour a decline which means we have a conflict between the wave count and the ESI. Perhaps the trend has turned down but the FTSE will bounce back as it is oversold.

This is why I am reluctant to go heavily long in case the rally is a counter trend in a short term decline. If the trend has turned down the ESI will remain bearish and the FTSE will find resistance near 6625. This is a possibility because the events in Ukraine could lead to more problems. The sanctions announced yesterday are very soft, this is why the stock market rallied. It seems the US and Europe have kept the more severe sanctions for later in case Russia annexes Crimea or invades eastern Ukraine. If Russia was to escalate the crisis, more severe sanctions would be announced and the stock market would sell off. This is a difficult time to trade because we should be long at a time when the risk of a sell off is high. We can't predict what Russia will do next but we can be cautious with our portfolio, until the smoke clears.

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