Why bears got it wrong

End of Day Update:

On Tuesday the S&P500 extended Monday’s breakout to record highs. While the gains were modest, traders were more inclined to buy these highs than take profits. But this is no surprise to regular readers of this blog. Last week I warned bulls to close their shorts proactively and take losses while they were small.

Quoting Thursday’s free blog post:

Anyone who is still short this market is probably only a little in the red. Rather than hope and pray for the selloff that isn’t happening, a smart trader admits defeat and takes his losses while they are small. This bearish trade has been given every opportunity to work, but this simply isn’t the right environment to be short. Be proactive and close a trade that isn’t working when the losses are small, rather than wait until the pain of losing money gets so strong it forces you out.

There is no magic to this. Basic market psychology and supply and demand told us the path of least resistance was still higher. In early August we tumbled when Trump and North Korea fell into a war of words that quickly escalated into North Korean missile and nuclear bomb tests. Then the Trump administration endured a rash of turnover in its senior ranks and at the same time exchanged barbs with senior Republican leaders. And finally two hurricanes did their best to pummel the Gulf Coast. Any one of those things would have crushed a vulnerable market. Put them all together and it creates a storm only the strongest market could endure. Yet that is exactly what we did.

The thing to remember is market crashes are breathtakingly fast and the only way to survive them is to sell first and ask questions later. But this latest selloff occurred in slow motion. In nearly a month of selling we only managed to dip 2% from all-time highs. That was after an endless string of negative headlines. Bears had their perfect storm, yet the market was still standing. That was the clearest warning possible that bears were on the wrong side.

As I’ve been writing for months, confident owners are keeping supply tight. While conventional wisdom tells us complacent markets are prone to collapse, what it forgets to mention is these periods of complacency last far longer than anyone expects. That’s because confident owners keep supply tight when they refuse to sell every headline and dip. If owners don’t sell the news, it stops mattering. That is exactly what was happened over the last month.

Since early August, nervous owners were bailing out of the market and selling to far more confident dip buyers. These new owners showed a willingness to own this uncertainty. In a bit of a self-fulfilling prophecy, those that confidently bought were willing to own the risk and uncertainty. Because they didn’t sell the fear, supply dried up and we bounced. News gets priced in once those that are afraid of it sell to new buyers who don’t fear it.

But that was then and this is now. What most readers want to know is what comes next. Plain and simple, expect more of the same. If we were going to breakdown, it would have happened by now. The path of least resistance is still higher. Nothing calms nerves like rising prices and this breakout to record highs is making the fears of the last several weeks fade from memory. Fear of the unknown is quickly being replaced by fear of being left behind. Big money managers are returning from summer vacation and they will start positioning their portfolios for year-end. Many of the underweight managers are coming to the realization that the dip they were waiting for isn’t going to happen. The pressure of being left behind will force them to chase prices higher into year-end.

This is a slow-moving market and I don’t expect us to launch higher, but expect the slow rate of gains to continue. A market that refuses to go down will eventually go up and that is what is happening here. Recent sellers will realize their mistake and fuel the next round of buying. I expect volatility to pick up this fall, but every dip is a buying opportunity. Stick with your buy-and-hold positions and keep adding when prices slip. This bull market will eventually break like every one that came before it, but we are not at that point yet. If you are out of the market don’t chase prices higher, but if you want to get in, be ready to jump on any dip.

Jani

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