The real reason the market surged

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Two days ago my free blog post was titled “Why Tuesday was a great day.” Even though the index only finished 0.3% higher, the market’s resilience was impressive given the bearish trade war headlines dominating the financial press.

“There are few things more bullish than a market that fails to go down on bad news. That tells us most of the bearishness has already been priced in. Over the last two months, we have witnessed a ton of selling. But what happens every time a fearful owner bails out? He sells his stocks at a steep discount to a confident dip buyer who is willing to own those risks.

Over time these fearful sellers are replaced by confident buyers and there comes the point in every dip where we run out of fearful sellers. Once everyone who fears the headlines sells, there is no one left to sell and the headlines stop mattering. That is what happened today. Trump threatened to take his trade war nuclear, and the market yawned.”

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While I liked what I saw Tuesday, even I was caught off guard by Wednesday’s explosive surge higher in one of the biggest up-days of the year.

People often claim no one can predict the market, but that isn’t entirely true. I had zero idea the Fed Chairman would soften his stance on rate hikes Wednesday, but I didn’t need to know that to make an intelligent trading decision Tuesday.

I will be the first to admit I cannot predict the news. But the thing to remember is the news doesn’t matter, only the market’s reaction to the news. That one small shift in perspective totally changes how we go about figuring out the market’s next move.

Every day traders are bombarded with both bullish and bearish headlines. As traders, it is our job to decide how to interpret these conflicting signals. Sometimes traders gravitate to one piece of news while totally ignoring another one. But even more important than what traders think, is how they trade. Headlines don’t move markets. Neither does the opinion of traders. Only buying and selling moves markets and that is what we must pay attention to.

Trump’s latest threats to escalate his trade war and tax all Chinese imports at 25% was obviously a very negative headline. A big chunk of October’s correction was based on investors’ fears the trade war was damaging the global economy. There is no dispute Trump fanning those flames this week was bad. And given October’s plunge, clearly traders are worried about the trade war. But given all the negativity, why did the market finish Tuesday  0.3% higher?

It’s not because the news was good. Or because traders don’t fear the fallout of a trade war. It’s because everyone who fears the trade war already sold their stocks and they had nothing left to sell. Once an investor is out of the market, his opinion stops mattering.

We can think of the market like a stalled car on a hill. It takes almost zero effort to push the car downhill, while it takes nearly all of our strength to move it one foot uphill. There are times when the market is similar askew. This time it was nearly impossible for bearish headlines to push us any lower because we exhausted the supply of fearful sellers. But in the opposite direction, it only a few words from the Fed Chairman to launch one of the biggest buying frenzies of the year.

Without a doubt, it is impossible to predict the news, but if we know what to pay attention to, it isn’t hard to figure out which way the market wants to go. Then it simply becomes a matter of waiting for the right story to come along and give us a push.

And going back to what I wrote Tuesday because it is equally relevant today:

“The next most obvious target is reclaiming 2,700 support, and the 200dma after that. We are not out of the woods yet and we should expect volatility to stick around. But the swings are getting smaller and the fear of a collapse are dissipating. We currently find ourselves near the lower end of the trading range and are in a place where the market is brushing off bearish headlines. That tells me the near-term path of least resistance is higher. Things will look different after we run up to the 200dma, but we will discuss what comes after that when we get there.”

Everything played out as expected…..except I certainly didn’t expect to be talking about the market running into 200dma resistance 48 hours later. But here we are.

The market was a great buy Monday and Tuesday. But risk is a function of height and Wednesday’s large gains make buying now a lot less attractive. A big chunk of Wednesday’s buying came from chasing and short-covering. Those are both fleeting phenomena and now that they’ve come and gone, we need another group of buyers to come in and push us higher. Unfortunately, many of those with cash remain nervous, especially following such a large move higher. Their fear of heights will likely keep a lid on prices for a few days. And even a dip back to 2,700 wouldn’t be a surprise. Two steps forward, one step back.

But now that we reclaimed 2,700 support, we need to hold this level. Tumbling under this level tells us buyers have zero confidence in this market and lower prices are still ahead of us. But that is the less likely outcome. Right now things look good because big money would rather buy the discounts than sell the dip. Expect a near-term dip as we digest Wednesday’s huge gains, but after that, expect the rebound to continue up to and above 2,800 over the next few weeks.

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Jani

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