Here’s How The Rally is Sowing the Seeds of Its Own End

Back on January 22, I pointed out that there was no chart resistance between 2700 and 2800 on the S&P 500. I felt that if the market cleared 2700 it would race to 2800 in the blink of an eye.

We’re almost there.

It has been an amazing rally. The market turned on a dime and has never looked back. To say that it was an unusual bottom is an understatement. But that’s history and this isn’t about post mortems, it’s about figuring out where the market is headed from here.

For now, it still looks higher. Here’s what you should look for.

I told my Technical Trader subscribers on Monday that cycle projections had risen to 2810 for short term cycles, and 2900 to 2960 for intermediate cycles. Those projections don’t have to be met, but the rally’s momentum so far suggests that there’s a good shot that they will.

2816 is a line in the sand for bears. That’s the area of a couple of pivot highs on the way down. If that’s crossed, the bear case would technically be dead, regardless of what the forces of macro liquidity tell us.

Macro liquidity ultimately will matter, but I believe that this move is a mania. Manias create their own liquidity through the expansion of leverage, essentially margin borrowing and repo. That rapid expansion of leverage creates the seeds of its own undoing. But it will go on until exhaustion. Some indicators now say that won’t happen until the highs of last September are at least challenged, if not broken slightly.

If 2816 is cleared, I think that there’s a very strong chance that we’ll see 2900 again, and perhaps new highs. However, I’d be on the lookout for topping action at 2800-16 first. If that’s cleared, then I’d set my sights on 2900+.

This chart is instructive. I posted it on January 26, showing that if the trendline convergence near 2680 was cleared, the next target would be 2750, where I expected a pitched battle. That battle didn’t last long. The bulls rammed it across on Friday and they are holding their own today. It’s obvious that the next target here is the 2800 area.

There are two reasons for that. First is the 3 peaks in that range from October to December. Then there’s the long term trendline from the April 2017 low. That trendline should attract some trading congestion, which could lead to reversal if they can’t clear 2816. If they do clear 2816, it will be off to the races, and our trading research gurus can provide you with options plays that could generate big profits for you.

Regardless of how long this goes on, the risk of a violent reversal grows along with the rally. So I’d be content to stay in T-bills, and play the market at the margin using a small portion of your total capital for trading purposes.

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Part of this mania is based on the hopium that the Fed will restart QE in support of the market and the US economy sooner or later.

But the very rally that this hope has driven is heading the Fed off at the pass. A stock market headed into the stratosphere will not give the Fed an excuse to slow its balance sheet normalization. In fact, it will encourage the Fed to stay the course and continue draining reserves from the system. Heck, even the bond market is still trying to rally, although, in reality, it’s been locked in a trading range for the past 6 weeks. I think that will turn into a reversal pattern, with yields moving higher.

If the stock market rally progresses, rising stock prices are likely to restimulate retail sales. Moreover, we already have very strong wage inflation in excess of 3%. Wage inflation has been accelerating, not receding. That will start to affect consumer prices. Likewise, gold is showing signs of perking up. Is the firming of gold a sign of geopolitical uncertainties, or is it a sign that inflation is rearing its ugly head? I think that the seeds of a resurgence of CPI inflation are in place.

So the hope of an actual Fed easing is likely to be misplaced. If CPI and yields start to perk up, along with the rise in stocks, it will begin to dawn on traders that the rally was based on false hope. The rally could evaporate as quickly as it came about. It’s a delicate dance.

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