Still Expecting A Sizable Rally

I want to remind everyone of something that Alan Greenspan said 20+ years ago:

“It's only when the markets are perceived to have exhausted themselves on the downside that they turn.”

When the market comes out with a bad economic report, and price does not tank as it did in the past, that is often an anecdotal sign of sellers beginning to exhaust themselves.  Moreover, when the market provides us with positive divergences on multiple time frames – especially the daily one – then that is also a sign of sellers beginning to exhaust themselves.  And, when we see divergences this stark on the daily chart, it is often a warning that a strong rally can take shape in the opposite direction.

Now, sometimes, we can see a catalyst which triggers the move in the opposite direction.  Yet, it is not really needed, as many market studies have shown that many large moves do not even see a catalyst.

In a 1988 study conducted by Cutler, Poterba, and Summers entitled “What Moves Stock Prices,” they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY.   Yes, you heard me right.  They were not even at the stage yet of developing a prospective prediction model.

However, the study concluded that “[m]acroeconomic news . . . explains only about one fifth of the movements in stock market prices.”  In fact, they even noted that “many of the largest market movements in recent years have occurred on days when there were no major news events.” They also concluded that “[t]here is surprisingly small effect [from] big news [of] political developments . . . and international events.” They also suggest that:

“The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases casts doubt on the view that stock price movements are fully explicable by news. . . “

In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news.   Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.

In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were NOT linked to any news items:

“Most such jumps weren’t directly associated with any news at all, and most news items didn’t cause any jumps.”   

Those of you that have been members for some time likely have seen these before.  But, it does not change the fact that they provide us with facts regarding how markets move.   

Thus far, the market has made several attempts at hitting the blue box support region on the 60-minute SPX chart.  And, each time, divergences continue to grow.  And, if you look at the 5-minute SPX chart, there is still opportunity to actually strike that support below as long as we remain below the smaller degree resistance noted.

So, to make this rather simple, when we see divergences of this extent, it is often (but, not always) indicative of a strong rally likely taking hold in the near term.  Whether the market is going to drop into the support region or not is not easy to tell since the decline looks quite full, and it is quite overlapping.    But, I think we will likely be much higher than where we stand today as we look out towards the end of October, or even into early November, depending on how long it takes the market to bottom out, and how fast the rally I expect takes hold.

And, I again want to remind you that the nature of the rally will likely provide clues between the green and red counts, which is the major issue on all our minds.