The tide is high but I’m holding on
-Blondie

It ain’t over ’til it’s over
-Yogi Berra

Since the March lows, the S&P 500 has rallied roughly 50%. There are two forces that determine market prices: buyers and sellers. In a healthy uptrend, buyers overwhelm sellers, demand far exceeds supply, and prices are propelled higher.

On the flip side, markets can be moved higher without a huge increase in demand. This happens when sellers retreat. In short, the market can be moved higher on weak demand so long as supply is even weaker.

Since the lows, buying has lacked vigor and sellers have all but vanished. These observations have been the primary thrust behind my risk aversion thesis.

In the last couple of weeks, I have observed small improvements in both volume and demand. This change is worth noting as it differs from the behavior seen since March. Notable as this change is, it is only one of many data points. The most important observation in reference to this improvement is follow through. Will volume and demand continue to improve? If the market begins to retrace, will heavy selling emerge? For the time being, traders are finding every reason to increase their risk. At some point, de-risking will replace re-risking, and sellers will overwhelm buyers.

There are a myriad of data points–both technical and fundamental–that lead me to believe the March low was not THE LOW. As mentioned, the rally from the march lows was not a function of vicious buying, rather the result of a retreat in selling.

In the shorter term, there are signs emerging that hint at trouble for equities. Credit spreads are widening and the credit markets have begun selling off. Premiums in default swaps are rising which hints that big players are putting on flight to safety trades. During a conversation with a well-known billionaire this week, he opined that credit markets (as opposed to equities) are beginning to better reflect the fundamentals. The disconnect between credit and equity will not persist indefinitely.

Given the overbought nature of equities off the July lows, it won’t be a surprise to see the market give back some of it’s recent gains. When the market does sell off, it may do so far more substantially than the majority are prepared for. Jesse always used to remind me:

“Stocks are manipulated to the highest point possible and then sold to the public on the way down.”

Where that highest point of manipulation is remains elusive. At some point the inevitable catalyst lower will emerge. Before it does, there will be plenty of clues.

This detective will remain on the case.

In the final days of July, I mentioned China Stocks being down 5% in a day. There didn’t seem to be much follow through to the downside, so traders piled back in, fearing they’d sold out in a panic. As soon as they all bought back in, the market turned right around and has since sold off severely. The same traders that sold out, then bought back in, are now holding–hoping that prices come back so they can get out at break even. When there is too much hope in a market, as seems to be the case here, it will likely fall until the hope transitions to fear.

The first chart is a daily chart showing the recent selloff. The second chart is a weekly chart. The weekly chart shows that the rally from the October lows was a correction within a larger downtrend.

Shanghai Stock Exchange - Daily

Shanghai Stock Exchange - Weekly

“I’d be a bum on the street with a tin cup if the markets were always efficient.”
-Warren Buffett

“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”
-George Soros

“The Matrix is the world that has been pulled over your eyes to blind you from the truth.”
-Morpheus

“Contrary investing is an art. Big money can be made betting against the herd. But the herd often gathers considerable momentum. The art is in knowing when it’s running out of steam.”

The Financial Times reports on yet another clandestine form of support the FED gives to banks. What better way to enhance profits at banks then to allow the banks to sell assets to the FED at inflated prices?

“In the interests of transparency, it (the FED) often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.”

Rigged markets lead to disconnects. This time will be no different.

China Stocks Plunge Most in Eight Months (Bloomberg)

Shanghai Stock Exchange