Sunday, February 13, 2011


As I sat up in my game room today looking out at a beautiful sunset with the cobalt blue ocean and San Clemente Island in clear view, I began to wonder if this all going away? Do the ducks in my pond at the back of my property that I was looking over to see the ocean have it really figured out. They were just cruising around in circles having the time of their life staying in the moment. Maybe I should just stay more in the moment and not sweat the big stuff? While I was standing at my pool table drinking my glass of wine, a thought came into my head. That thought was of how fortunate I am to have enjoyed what I have in life thus far. I never dreamed as a kid growing up in a small town in Michigan, that I would have the life I have now. One of the great things about life itself is the endless possibilities it presents. Of course they can be both good and bad. As hard as we try to always make everything work out well, that does not always turn out to be the case. As I pondered all of this I wondered if some of the doomsayers might be right. Might all of these great things we have enjoyed as Americans be in jeopardy now? Could all of this go away? I always like to consider the opposing views. It is way too arrogant no matter who you are to assume you have it all figured out, and people who do not agree with you are wrong. I have been wrong too many times in my life to ever have that type of attitude.

Life is good right now, we have what I would argue is either the greatest stock rally in history, or perhaps the second greatest one. I have been wrong a good bit on this rally. I did not think it was going to develop into this moonshot. When the low in 09 was made I thought we still had a little more to go. Then once we got going and it was obvious that low was going to hold, I did not think we would go this far this fast. I am going to show some charts in a second, of the prior periods that most closely resemble this type of moonshot action, with virtually no pullbacks in price. Let's set aside the political backdrop and why this is happening. Let's just focus on the price action itself, and what has followed when we have had patterns like this. It is somewhat subjective I guess as to what is similar and what is not. What I looked for was mostly straight up action for about two years with very minimal pullbacks. Just straight up matching the price action, nothing else. The Genesis software allows such a search.

There is a wide breadth of optimism spreading quickly now, and even I have to admit as I watch intraday price action, it becomes almost inconceivable to think we might ever have two consecutive days that close lower ever again. I have launched a professional comedy career all based on one joke suggesting we might at some point have a day that closes lower than the day before. The VIX is tanking, indicating complacency, and every sell indication imaginable results in a bad trade. Is there any chance this might not be as rosy as it appears? The unemployment rate is declining, our wonderful stimulus plans are working. We are getting ready to now bail out individual states, what is to worry about? The government can do it all for us! In the world of contrarian thinking, this would all else being equal, be the perfect storm for a major top.

What we seem to have here in these prior periods are corrections and in some cases reversals. Of these 4 there is one that just continues going, this last one. Maybe that will continue, we just never know. What I do find when doing this type of exercise is that when I can find one or two examples that are virtually identical, it is uncanny how accurately the future follows what they have done in the past. With that in mind I consider the first two examples to be the most closely correlated to the current price pattern. It is why I listed them in this order. The computer also gave them the highest percentage match in the search and rightfully so.

These are just graphic examples of why I have been telling people to tighten their stops on longs. We may well sail on into new all time highs, nothing at all would surprise me at this point. If we do trailing stops will not be hit. However, for the most part these past searches have shown us that these types of runs tend to have severe corrections to them. I know when I read some well educated folks talking about the coming food crisis and inflation, it all seems a bit scary. Could we really see riots in this country? I do not know why we could not. After all we have union workers with no high school educations making 6 figures in the auto industry and crying bloody murder when they hear other people don't think they should be exempt from Barry Care. This is a large part of our society that is so used to having it so much better than most people, they are not prepared for even the slightest change in their way of life. With that being in place don't you think they would be the first people to cry if things got really rough? Of course they would. The government knows this so they subsidize them, the new American way. One other thing to consider here, the FED is on a mission from God to try and ramp up inflation. There is only one reason no matter what side of the fence you stand on, that they would be doing that. They fear a big deflation wave that could be very difficult on all of us, and they are fighting off that possibility with all that they have.

When I listen to the news and hear an attorney criticizing an Arizona rancher who is protecting his property for the type of gun he has, instead of criticizing the illegal aliens who endanger him, it makes me realize we really do need a reset. We need to get guys like this crying for help. Of course this guy will be the first guy to call for help if he ever gets into trouble with illegal aliens. These cowards are all the same, and to me they typify what is wrong with America today. We have too many soft little punks like him rooting against the average good citizen, trying to make money from it. Just anecdotally this tells me we are going to have a period at some point where this type of thing gets weeded out to some degree and that can only happen during a crisis period. As long as things are good we will always have guys like him.

Of course I am talking philosophically here, but this is just a general post on what could happen. The FED has rallied the stock market artificially to try and jump start everything else, without ever allowing all the problems that caused our crisis period to get resolved. They are inflating a massive asset bubble that when it starts leaking oil, it is going to be something most of us have never lived through before. As long as the stock market is rallying everything is good, if it were to turn down, you will see things change dramatically very quickly in this country.

The common theory I hear now is that stocks will trade down and commodities will sky rocket causing runaway inflation. I have seen some arguments that make sense that support this but history does not. It is hard for me to imagine during a depression that prices would not also decline. The logic for the commodity price rise is that producers cut back due to lack of funds and therefore supply gets limited, driving prices way up. It could happen, but it has not been the historical pattern. The FED has rewritten rules of the markets that have stood for decades, so do not dismiss any possibility. All bets are off. However, one thing to keep in mind, in the past during difficult economic periods, commodity prices have declined not rallied. This is always what bothers me about these arguments. As much as they are founded on logic at some level, they all call for something that has not happened before. They are "it is different this time" arguments.

One characteristic of market movements that has remained constant is that markets tend to come out of moves the way they came in them. We had a V bottom in 09 when almost nobody called for that. We came into that on a sharp decline, then turned on a dime literally one day. Since we are going virtually straight up now, we will likely turn on a dime when we do reverse. I think the best strategy for even those who might be bearish is to draw a regression channel on prices, and just keep a close only trailing stop on your longs below the bottom of the channel. There is no telling how far this could go. I will say the one thing I am sure of is that when it turns, it will do it on a dime, not over a period of time. When air pockets/bubbles get inflated this far, they crash when they do finally turn. We may do it from 16,000 DOW or next week, I have no idea. Trail your stops and rake in as much as you can, this is a once in a multi decade type of run we are having. If you look back to the 90's and the Internet crash, the market pulled back many times on it's journey, that has not happened this time. This rally makes that look like a blip in terms of the internals of the move.

Regression channels just like most techniques, have their shortcomings. However, when you get in runs like this I think they work pretty well. You can see how well it worked at the 09 lows in terms of just telling you to get out of your short positions. Here it would have you carrying a pretty wide trailing stop since we have extended out into the top of the channel. Who is to say we don't correct a little at some point and go to 20,000 in the DOW. You really have to keep an open mind to all possibilities. You cannot let an emotional view on what "should" or "should not" be happening, get in the way of how you manage a trade. What is happening is all that matters.

As I always do, I will attempt to point out when I think we have sell signals in the indexes to give us a fair warning of a top. There are no short term sells out there in most of my indicators. I did show the megaphone pattern in the vix the other day, which is not really something I trade with. It is something I monitor to look for entries in my other indicators. Since none of them are here yet, there is nothing to do but stand up and applaud.

I am in the process of developing the PNJ Advisors web site, in a couple of weeks it will be up and running.

Good Trading to everyone this week

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