This Historic Chart (Still) Foreshadows a Stock Market Surge

I get a daily e-mail with a very brief analysis that recaps something that just happened in the markets.

Last week, I got one that included this sentence: "[For the markets] The narrative seems to have totally changed in the past 3 weeks."

What narrative is that?

The one where everything is going to hell in a handbasket.

What follows below is what I said to some of my subscribers 4 weeks ago, before the "narrative totally changed."

We’re publishing it for you because I think it’s just as relevant today as it was prescient last month.

Enjoy.

***

Everywhere I turn, someone is proposing another reason to be bearish on, well, everything:

  The U.S. economy is falling into recession.

  China’s economy is collapsing.

  Crude oil is doomed forever.

  Corporate leverage indicates a new era of earnings downgrades.

  Junk bonds will trigger a financial crisis.

  American exceptionalism is on the decline.

That last tip comes from the ever-illustrious GOP presidential candidates. I have varying, and in some cases significant, amounts of aversion to all the candidates but one. But I can agree with their overarching conclusions.

I also agree with evidence that analysts and economists bring forth. It indicates a global recession is a real potential and a real threat to markets.

But something isn’t quite sitting right for me.

Something bothers me about the timing.

I think the timing is too obvious. That it ignores the human-nature element inherent in markets and, to a less-conspicuous degree, economies.

The groans are loud.

And the aversion to risky assets speaks volumes.

U.S. Panic / Euphoria Model

Source: CITI

U.S. investors are in panic mode. And it suggests now is not necessarily the appropriate time to run scared.

My proclivity for contrarianism, of course, is not the be-all, end-all.

Things could get worse, as this chart of short interest in the S&P 1,500 suggests:

Source: Bespoke Investment Group

Short interest during the great financial crisis reached nearly twice the level at which it stands now.

So, yes — trillions more in market cap could be wiped out if investor perceptions do not stabilize.

The fundamentals certainly provide for calm. And the system as a whole is uncomfortably dependent on perceptions.

But short interest is the highest it’s been in three years. And if we agree that the current global economic stagnation will not beget another major financial crisis, then maybe the chart above suggests bearishness is overdone.

There is something else I’d like to bring to your attention …

This historic chart from Bob Prechter of Elliott Wave fame suggests today’s environment of stagnating growth and growth expectations is a breeding ground of a blow-off, bull-market rally.

This morning, when I was perusing through Elliot Wave Principle — the book Prechter co-authored with A.J. Frost — I noticed that pattern (Wave IV in the chart above) in many of their examples.

Maybe I noticed it because it’s quite similar to the current pattern on a weekly chart of the S&P 500:

Again, this type of analysis is somewhat circumstantial. But it shouldn’t be overlooked.

As long as you — an investor — can be nimble or prudent with risk controls (or both), then I see no reason why this market shouldn’t be bought right now with the initial intent of making some short-term profits on a test of the highs.

Some things need to happen before we see any confirmation that a major, bull-market blow-off rally is in the making.

But technical and sentiment analysis already suggest it’s a possibility. And policymakers are scrambling to reaffirm their commitment to financial market stability.

Indeed, I think policymakers still have wiggle room. Governments still have a willingness to assume even greater amounts of debt — especially if it means keeping households and businesses relatively solvent.

And they’re going to use that wiggle room for as long as they can.

Do right,

JR Crooks

“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also…