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Sentiment is bullish and the S&P 500 is not far away from making a new all-time high. Stock markets don’t make all-time highs for the wrong reasons. It seems we live in a world where men and women can dictate the direction of the stock market. They’ve done it with quantitative easing, and now with negative interest rates (in Japan, Europe, Switzerland, Sweden and Denmark). Which country is next?
The people at the top of financial engineering are playing with fire, they are experiencing something new, something that has never been done at this magnitude. Will it backfire? Sure it will. History tells us that the stock market can be manipulated but not indefinitely. There will be a time when the market will have enough, it will turn down and remain down for many years. This moment is fast approaching. You will note that I am talking about the S&P which is still trading near its all-time high. The FTSE 100 has already turned down, the UK index peaked in April 2015.
As you can see the FTSE is the leading index, it is the best stock market in terms of predictive power. The UK index anticipates changes in the economy. When the FTSE is in a bull market the economy will expand. When it is in a bear market the economy will contract. In April 2015 the UK economy was stronger than it is today, but the UK index did not wait for 2016 before turning down. Today we see weaker economic numbers in the UK, the FTSE 100 index anticipated this change.
We are now bouncing back from the February low, the move is a second wave and that is why many people feel bullish. People feel bullish because second waves are powerful, they don’t retrace 20% or 30% of the first wave, they retrace 50% or more like 60%, 70% or 99% of the first wave. In the S&P the retracement is near 95%, in the UK the rally ended near the 50% retracement, this level is 6445.
Second waves in a bear market create an illusion, the illusion that the bull market is still underway. I am not saying the S&P won’t break above 2134.5 which is the all-time high, but if there is a time to short the US index it’s now because the second wave has retraced near the maximum retracement level. The bottom line is, don’t be distracted by a second wave, it may unfold over a long period of time and give the impression that the market is bullish but when it ends, the next move will be a powerful decline lasting many months or years depending what degree of trend you look at.
Right now the larger degree of trend is wave (3) down. Inside this wave we have wave 1 to 6050 and wave 2 up which is the current rally. The next move will be a third of a third [wave 3 inside wave (3)] which is very powerful. The index could collapse in a short period of time during June-July. Of course if the S&P makes a new all-time high above 2134.5 this will change, in this event the powerful decline that I am talking about will be delayed. But the threat of lower prices as we move into the second half of the year will remain.
Thierry Laduguie is Trading Strategist at www.e-yield.com
