Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'?

Source: CNBC

And, if you based your stock market buys and sells upon these fundamentals, well, then you were likely left out in the cold.

Again, please recognize that most analysts considered us within a recession during a time when the S&P 500 rallied 1500 points off the low, with the majority of investors believing that we had begun a major bear market. If you do not understand why they got it so wrong, I again suggest you read the article about fundamentals that I linked above.

Yet, many still believe that the market should follow the fundamentals. While one of my members recently commented that “March 2020 should have been the last straw for any FA traders,” I would not be shocked if the commenter above is still following his old fundamental perspective despite being taught a lesson in 2020.

But, I do not think it is likely that this commenter has abandoned his perspective. It has been too engrained in the common perception of the stock market held by investors, so most have not likely learned any lessons. Rather, it is clear that the majority of investors will simply lick their wounds and continue along this same path no matter how many times they get caught on the wrong side of the market.

In fact, this past week, another one of my members posted this quote from someone on Twitter:

“The fact that stocks are up today after that horrible 7% CPI print shows what a farce this "market" is. It's completely disconnected from reality and from the fundamentals. There are no analysts anymore. What is there to analyze? If you're in this market, you are gambling.”

Well, actually, it does not mean you are gambling. It simply means that this person (as well as most market participants) just does not understand what really drives the market. And, if what you are doing is not working, isn’t it time to consider something else that may?

In my view, the market and fundamentals are both driven by investor sentiment, and not economics or news. If you would like to understand a bit more about my perspective as to how the market works, this is the six-part series I wrote about my views on how to track the market.

In fact, I am forthwith issuing a challenge to each and every one of you who truly believe that news or fundamentals are what direct the market moves. If you have a modicum of objectivity and intellectual honesty, and are truly interested in the truth about financial markets, I challenge you to read The Socionomic Theory of Finance. It takes just the first three chapters to turn your perspective on its head, based upon real world examples and facts. Once you begin to realize the truth, you will never look at the financial markets in the same way again.

Within that book, the author highlights how many high-profile economists questioned the traditional view of fundamentals and economics after it failed to prepare investors for the 2008 financial crisis. And, many of them noted that much of their failure was due to their inability to take into account factors like human psychology and human behavior.

Yet, admittedly, they noted that they needed to have something to replace their theories of efficient markets, but they have yet to find a workable paradigm. And, without a replacement, they were still forced to use their old perspectives on efficient markets despite their recognition of its massive failings.

The author also brilliantly outlines why the old paradigms fail, and explains how to view market sentiment and social mood as a new paradigm and insight into market movements.

And, once you learn how to adopt this new perspective, you will not be scratching your head at market movements such as those noted above. So, consider reading this book as Morpheus presenting you the opportunity to choose between the blue pill and the red pill. It’s your choice. But, recognize that your perspective will likely be forever changed.

Now, does our belief that we understand the underlying truth and driver of market direction mean that we will always be perfect in our market assessment? Heaven forbid we would ever suggest such a thing, as we are still human and will never be able to be perfect in the market.

But, it means we have an objective perspective to tell us if we are right or wrong rather quickly, and be able to adjust our positioning a lot faster than most investors in the market.

Last week was a perfect example of our inability to attain perfection, which is quite apropos considering the title of my missive the prior week.

While my initial assessment last weekend would have viewed a break down of the 4600 region in the futures as opening “the door to a direct move down to the 4400SPX region sooner rather than later,” we did break down below that support, yet did not continue the move to 4400SPX.

While the door certainly opened for a continued move down to 4400 as we spiked down 30 points lower than that support, when we came right back up before the market close through the resistance we should have held, it told us that it was likely a false break down.

However, during that break in real-time, I was not viewing that break of support as strongly indicative of a direct break down towards the 4400SPX region. Rather, the structure of the market break down was telling me at that time that it was potentially a false break of support, and the market coming right back up through the 4625 level in the futures before the market close told me that is indeed what occurred.

You see, what sets our analysis apart is that we have objective standards which we apply to the market structure we are tracking in real time which tells us very early on whether we are right or wrong in our assessment.

Therefore, it allows us to adjust quite quickly when the market makes it clear that we are wrong. And, we are not swayed by the false narratives which cause most market participants to be looking in the wrong direction right before a major change in direction occurs.

So, when the market broke back up through the 4625 level on the futures, it had me again seeing it as a strong potential that we can still rally to higher highs before we may see that pullback towards the 4400SPX region.

For those that want a bit more detail about the Elliott Wave structure that we are tracking, the S&P 500 seems to be forming an ending diagonal off the early December pullback low. Ending diagonals are known for their whipsaw, complexity, and volatility as they complete a topping structure. And, I recognized this potential once the market broke back down below the 4700 region from the recent all-time high.

One of the other hallmarks of an ending diagonal structure is that the market often spikes up in a blow off top in its final move higher, only to reverse just as strongly when it completes. Moreover, that reversal will often see a strong move down towards the region from which the pattern originated.

So, this is what I will be tracking over the coming weeks. And, if we do get a higher high over the coming week or two, I think we can see a mini-crash-like event that will take us from the new all-time high back to the 4500’s rather quickly.

But, of course, I need to know where I am wrong in this potential assessment. You see, the market is attempting to transition from one phase to another, as I told you to expect in the first quarter of 2022, in order to prepare us for our next major rally to 5500SPX. And, this one has turned much more complex than I expected. So, if we see a break down below the low struck the other week—4580SPX—then I have to give in to the near-term bears, and view us as potentially heading down to the 4300-4400 region sooner than I had initially expected.

So, in the bigger picture, I think the market has a cap in the 4882-4960SPX region. And, I still think we should see a pullback down to the 4300-4485SPX region before we begin the next major rally I foresee to 5500SPX over the coming year or so.

Lastly, for those that do not appreciate what I write about my perspective on market fundamentals, or anything else I write, you really do not have to read me anymore, as I will certainly not force you to do so.

Keep in mind that I began my career using fundamental analysis for the market just as have most of you. Yet, I made an educated decision to switch to primarily analyzing market sentiment since I viewed it as providing me a much more accurate assessment of market dynamics. So, unless you understand what I understand about both sides of the market, you simply cannot make a qualitative assessment of my decision. In other words, I clearly understand your perspective quite well, but do you understand mine?

Written By: Avi Gilburt