"It is a capital mistake to theorize before one has data. Insensibly, one begins to twist facts to suit theories, instead of theories to suit facts."
-- Arthur Conan Doyle
I've written quite a bit recently about why it is so important to focus on price action rather than big picture arguments. Using logical arguments about economics, fundamentals, politics, central banks or any of the many other things that impact the market simply hasn't worked.
In 2016 there were two big bearish narratives that failed to work. First was the argument that Brexit would be a disaster because of the uncertainty it would create for the European Union. Second was the argument that the election of Donald Trump would be a disaster because of the uncertainty that he would create. Both narratives proved to be wildly incorrect, although the logic employed by the bears appeared to be very clear and compelling.
In recent weeks, another bearish narrative has developed. The argument has been that the market has been too optimistic about the policies of President Trump. The failure of healthcare reform shows that it won't be able to easily push through major changes and that tax reform is still uncertain and far down the road.
The market has had some negative reaction to this news, but the bearish narrative that it would produce a major turning point has been incorrect. This past Monday, the bears were ready to declare that a major top had occurred when the indices gapped down after contemplating the failure of healthcare over the weekend. Since the open on Monday morning, the indices have gone almost straight up and have seen strength build each day following the open.
The lesson here is obvious, but the trap is extremely hard for many market players to resist. The lesson is don't try to impose a narrative on the market, no matter how logical it may seem. The idea of a selloff because Donald Trump would cause uncertainty seems obvious, but the more obvious something is, the more this market is inclined to do the opposite.
Selling off on healthcare reform seemed obvious a week ago, but as the story evolved the market attitude shifted and the logical arguments for a selloff were ignored. As soon as people were ready to accept the idea that maybe the Trump rally had run its course, the market did the opposite.
Contrary thinking has always been an appealing trading strategy, but for years now it only seems to work in favor of the bulls. The bears constantly talk about complacency and too much optimism, but the market never reacts to it. On the other hand, when there are news events that seem to be clearly negative, the contrarian approach has worked extremely well. As soon as there is some negative pressure building, the buyers look to buy dips and weakness and the market reverses.
The bulls are feeling much confident after a strong three-day bounce and we will see now whether they can build on this further. Some of the bears have thrown in the towel, but there are still some technical issues out there with the charts. It is going to take some real buying energy to produce another V-shaped move back to highs.
It is the end of the quarter, which can create some positive pressure, but that often ends a day or two early, as some managers look to lock in gains and raise cash. The indices have weakened overnight and there is little news flow. The pattern has been weak opens and then steady gains during the day. Traders will be watching to play that scenario once again.
Focus on the price action, not the narratives.