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September 22, 2008

Keep an Eye on Sentiment

Late post tonight. The weather has finally turned nice here in Atlanta, and I simply had to get out and lounge around a bit. In a few more days, it should be absolutely delightful, and I'll make one of my autumn trips up into the mountains for some hiking. Autmun is my favorite time of year, weather-wise, so if I am occasionally delinquent with my posts in coming weeks, you will have to forgive me.

Anyway, despite paltry volume today, the stock market did not change its recent habit of wide ranges. For the fifth time in six days, the S&P 500 sported a 4% range, and today's session neutralized Friday's criminally-induced short squeeze. I had no strong opinion about what would happen today, though I did have a weak opinion, and in no way did that opinion account for a 4% slump. The market is coming off much weaker than anticipated. No complaints, however, as the short call position I am holding on the home builder ETF lost half its value, which is quite nice for the option writer (and you thought I could only write a blog).

The big question facing traders at this juncture concerns last week's low. Did we witness a significant bottom that will hold for a larger rally, or was last week's squeeze just a giant firecracker that is doomed to quickly fizzle? My guess is that either way, the market will find its way back to that low within a couple weeks. Let's turn to our old friend Elliott for an educated guess as to whether the low holds.

index chart

There are two reasons to suspect that the shaded area does not represent a completed wave 3 of 3. First, the first two waves of Wave 3 had durations of eight weeks and six weeks, respectively. It would be unreasonable to expect wave 3 to last less than three. In fact, it should last much longer than the first two. Second, every down wave during this bull has ended with sentiment readings on the put/call ratio and advance-decline volume at panic levels. Not so for last week's low. For these reasons, I am suspicious that we could get the result that no one expects: a very volatile decline that lasts several months and bottoms with those senitment indicators stretched to further extremes than other bottoms have produced. Just to spin things to the appropriate level of uncertainty, I will throw in the caveat that if price returns to last week's lows in conjunction with extreme sentiment readings, I will then start to question the interpretation just presented.

Commodities rallied hard today as part of what I still believe will turn out to be a sucker's rally. While this rally could extend further, it would be reasonable to expect at least a pause at this point since many commodities and commodity-related ETFs are bumping up against resistance levels. I will defer on posting charts as there is not really much to add. It is interesting to note, however, that the bond and currency markets are rejecting the Dukes' bailout package. The Dollar Index tanked more than 2% today... a phenomenal move... while the 10-year note has seen its yield up 60 basis points in four days. Incredible! I would venture to guess that the grand bull market in bonds is over. Its death knell was wrung by the Dukes last week, and the bond market is now going to force discipline upon the U.S. government.


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