Understanding that the market has topped and that the underlying mechanism is broken, fund managers will now look at their big pile of overpriced, overvalued equities and figure out a way to get the hell out without sending prices in a downward spiral. That's where you, dear retail investor, come in. What will happen next is meant to sucker every last buyer into the market. No fund manager wants to be left holding the bag when the market tanks. That's why over the next days, weeks, and possibly months, there will be a massive, institutional investor-funded rip-your-face-off rally that will serve to turn yesterday's fear back into good old fashioned greed. Once they get the rally started, it will turn into a virtuous cycle as momentum-chasing algorithms start buying into the rally. Then, retail investors, who don't want to be left behind but by this point will be late to the party, will start buying. So once institutional investors fire this rally up, algos and retail will take the ball and run with it, allowing those very same institutions to sell into strength that they initiated, ultimately exiting those overpriced, overvalued equities.
As you can see in the updated chart, I've tinted an area in green that more or less satisfies my rip-your-face-off rally thesis. We're now trading almost 10% off the lows from August 24 and above the 50 dma. Investors appear to be piling back into equities as the broader markets surge higher on terrible earnings reports. Everything is hunky-dory, right?
Umm, no. Everything is not hunky-dory. In fact, it's the opposite of hunky-dory. It's actually the worst thing that could be happening in the markets. For one, volume has been abysmal during the most recent rally...buyers are showing absolutely no conviction! Second, the momentum indicators have gone from oversold to way overbought. Third, and perhaps most importantly, the S&P is running head first into massive overhead supply. Do you see all of the trading activity that took place between 2050 and 2100? That's called overhead resistance in the form of thousands of investors looking to exit long positions as close to break-even as possible. Given the many months the S&P traded in that range, the heft of the overhead supply cannot be overstated.
I concluded the August 25 post with the following: "To summarize, the worst thing that can happen in the markets right now is a hard rally, effectively erasing much of the losses from the previous days. Unfortunately, that's exactly what I think is about to happen." As far as I'm concerned, that's exactly was has happened. Now we have to wait and see what Mr. Market wants to do next.