Trapping Bulls and Bears

What a day, and what a thesis we have for you. We're going to give you the analysis, but then go out on a limb for a bit of a unusual conclusion.

Unless you're dead, you probably know the stock market shot up today like a rocket. It's right on schedule for what we've been predicting for a couple of weeks--the dollar would fall and stocks would rally. After punishing the bears that jumped the gun on shorting the market last Monday, the market has been nothing but bullish. We're going back to 2007 in short order, right? Flipping condos, buying stuff from China, making nothing productive in the US, and living off of credit, right?

Obviously, we've become a bit jaded. Let's take a look at the charts. Today's darling was the stock market, so we'll start there.

We're using the weekly chart just for clarity, but the same actions apply to the daily chart.

The bulls jumped on a very overbought stock market today and took it higher. In fact, they took it into their own inverse head and shoulders pattern, that we pointed out earlier this week on the DJIA. For the S&P, that should run it up to 1350 or so, which in our opinion, was the primary reason that stocks rose so fast. That must mean everything is getting better, huh? Condo flipping time, right?

Maybe not. As we've shown above in red, we are approaching the top of the megaphone pattern, somewhere around 1000 on the S&P. The bulls may think we're in a bullish pattern, but there's something that they should remember. A pattern must meet all of the requirements of being a pattern, or it isn't a pattern. A week ago Monday, the bears that shorted the head and shoulders before the final neckline was severed got killed. It was a bear trap. This time, the bulls would be wise to remember the same lesson.

We are primarily in a bear market, with a bear market rally that began in March, until proven otherwise. That means that all patterns that are bullish must bear the burden of proof. Volume should rise when the price is rising, if we are really entering a new bull market. It is, instead, falling in aggregate, even though there is a minor increase in volume on the daily chart below. It is, *ahem*, unconvincing.


The daily chart shows the volume increase, though it is marginal at best. The market is extremely overbought, so it absolutely has to take some resting time.

Expect a pull back tomorrow, and possibly for the next few days. A retest of the 956 level is probably in order. The bulls will argue that this is a simple retest of the neckline break before moving on higher. I'm not so sure that will hold water. A close below 956 should send up some caution flags.

The bears don't have much of a case except on a pull back below 956. In fact, we wouldn't be surprised to see such a pull back where the bears go short around 950 and they get whipsawed one more time on a false breakdown.

The megaphone is still very much in play and is the pattern that we are most focused on for now. A run up to 1000 on euphoria is possible after, perhaps, a brief rest that bounces off of 956. If the market turns on 1000, be very, very cautious of the possible bearish broadening top. Though this pattern is not common, it was a very frequent turn pattern for stocks in October of 1929. Be forewarned that if this market now turns and closes at all below 890 before it breaches and holds 1000 to the upside, we think that implies that the overall market is headed down in one more, brutal leg down. This is a very, very dangerous position, and we would not add any new long stock positions until 1000 is successfully passed and the market shows buying strength going up.

Let's look at the dollar.

We're keeping the symmetrical triangle on there for reference. Now that it's broken down, just like clockwork, the dollar has bounced off of support around the 78.40 level. Just as predicted.

If we break down below the support region in the next few days, we'd say the bulls have a case and inflation is on the way. If it bounces hard and starts another run up, we're likely in for another serious case of deleveraging.

Assuming we have a reasonable bounce, how far would it go?



You can see the slow stochastic has been fantastic at showing the bottoms (and tops) in the dollar. Since the dollar is now oversold, as show by the slow stochastic, expect a bounce. We would first be wary of a strong dollar if the RSI at the top broke above the downtrend line. Second, we would be wary if the dollar broke above the 50 day moving average, which it has not done since most of the panic subsided late last year. Note the support levels in horizontal blue lines. We suspect that we'll rally close to the 50 day moving average at around 80, and barring a panic condition in the markets, the dollar will resume a downtrend there.

So now that we've seen the data, here's a hypothetical.

Since we are of some opinion that, while the markets have low volume, they are being supported behind the scenes. The real economy remains in trouble. There are no green shoots, but there are traps where the professional traders from the major investment banks may be ready to take your money. And here at Dredd, dear reader, that is an unacceptable end to this development.

We expect a pull back over time to 956, or just below intraday, as the dollar rallies toward its 50 dma. The bear will get excited and prepare to short the market. Much like we got a couple of weeks ago, the market will reverse. The bulls, confident that 1350 is in their sites, will pile in, but around 1000 or 1015 (the 38% retracement), they will run out of buyers and the rally will fade. This time, it will go down, and whatever is left of the bears will short the market at around 890, when the broadening top is obvious to everyone.

So the bulls and bears both get trapped. That's a nice way to run the table during the summer, eh? Of course, there's no guarantee that this is going to occur. However, it is a very plausible scenario if you believe that the markets are being played and the majority of trades are being executed by black boxes.

At some point these markets must decouple and move on their fundamentals. We would like to see that happen sooner rather than later. Right now, no one is investing. We're all gambling.

POSTSCRIPT: We forgot to mention that, in the longer view dollar chart, that it appears that the dollar may have made a double top. While double tops are often called, it's rare that they are actually double tops--one typically does not know until in hindsight. On confirmation is volume, which of course, is practically impossible to determine in the USDX. However, if it is a double top, one could expect the entirety of the rally from March of 2008 to be taken back, leading to a value of 72 on the USDX. Something to keep in mind.