Rev's Forum: Emotions Favor a Market Retreat; Logic Favors More Upside

 | Feb 17, 2017 | 7:13 AM EST
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"In the Soviet army it takes more courage to retreat than advance."

-- Joseph Stalin

The market's aggressive uptrend cooled on Thursday and early indications are for a soft open in front of the three-day President's Day weekend. Many market players are anxious to conclude that the Trump rally is coming to an end, but the technical action suggests that they should be patient about calling market tops.

The bears are happy to point out that the indices are extended, sentiment is unusually bullish and there are questions about how quickly and easily the Trump Administration will roll out tax cuts, Obamacare repeal and replace and other fiscal matters. The market has been very quick to react to numerous promises that these things are coming, but there is plenty of skepticism even among the bulls.

The bulls don't seem very impressed with these arguments. Sentiment has been a useless timing device in this market. The bullish sentiment has been elevated for nearly six weeks now, and the volatility indices seem unhinged from the market action. It is likely that although many market players are trying to keep pace with this strong market, they aren't totally convinced of the sustainability of the advance. There are many bulls, but they don't have much conviction or confidence, and that is a dynamic that helps to keep the uptrend going.

The biggest positive that the bulls have can be summed up in one word: momentum. Markets that are this strong don't die easily. They don't just suddenly reverse and go straight down, unless there are some significant news events.

Market players always worry about the possibility of being caught in a sudden market crash, but if you study all the major market collapses, you will see that they don't occur at highs. Major market crashes occur after there has been technical weakness for a while.

The psychology of why strong markets tend to stay strong is not complex. The people that have missed out are still anxious to join the party. They are disappointed or angry that they didn't optimize the opportunity to make some money and they are not going to let it occur again. They are going to take advantage of pullbacks and put money to work in their favorite stocks when they have a chance.

Robert Hanna of Quantifiable Edges studied what happens when the market moves straight up at least five days in a row to a 50-day high and then pullback. There were about 60 some cases and the market was higher a few days later about 60% of the time; 10 days later it was positive about 80% of the time. The results 10 days later was particularly positive with an average gain of 0.94%.

The message is clear: don't be in a rush to call market turns. It is an old market saying and sounds simplistic, but market tops are a process. They take a while to develop. It is a mistake to think they are a single point that will occur just because stocks are technical extended and bullish sentiment is high.

All markets have some unique aspects and what is most unique about this one is the sound and fury over Donald Trump. The press conference yesterday was a stunning display of the upheaval that is occurring in Washington and many bears see this as a catalyst for a market disaster at some point. They have been spectacularly wrong so far, but they aren't giving up on the idea that there will be a major Trumpian selloff sooner or later.

We have another soft open on the way, but that has been a bullish indicator lately. Early weakness has been bought every day for that past week and the indices have closed strong. With the three-day weekend beckoning there may be some hesitancy to boost long exposure, but market players are still far more concerned about finding new things to buy rather than selling things that are too strong.

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