Does the one day reversal pattern that was made on September 23rd mark the end of the near historic rise in the broad averages? Bearish technicians are pinning their hopes that this is the case.  One day reversal tops can be identified by a single day spike to the upside, making new highs for the move and then falling below the previous day’s low and closing near the day’s low and below the previous day’s low. Volume on the day of this pattern is often heavier than usual.  So far, this bearish indication appears to be working, which is attracting additional technical selling. However, keep in mind that the one day reversal pattern is the weakest of all of the reversal patterns. Just in case you are wondering, it’s the island that is the most reliable of the reversal patterns.                     

 

Our work suggests that this technical sign of weakness will ultimately fail, even though the bears appear to have gained the momentum, at least for now. While it is true that this reversal pattern is currently working, it is likely that the selling pressure will only draw more shorts into the market that will be forced to cover at higher prices later.   Our latest research suggests that the recent weakness in futures will prove to be another “bear trap.” Technical indicators tend work the best when the fundamentals are giving the same indications, which is not the case now. The fundamentals remain bullish, which is contrary to this bearish one day reversal pattern. The situation that we are seeing now is probably nothing more than a temporary pause in the existing uptrend.

OPPOSITE REACTION TO NEWS INDICATOR

There are several reasons why we believe that there is much more upside left in this market. One of these is how the market has reacted to news since the lows were made in March of this year. One question must be asked. Why have stock index futures been able to advance, with only a few pauses, in spite of so much negative sentiment surrounding the economy and the equity market outlook? One of our reasons for being long term bullish is the “opposite reaction to the news” indicator. Anytime a market is able to advance on bearish news it is a sign that prices are likely to move higher. Conversely, when bullish news is ignored and prices work lower it should be construed as an indication of further losses for that market in the near future. Since this bull market first began in the spring, we have seen a mountain of bearish news generally ignored, as futures prices advanced. The application of the “opposite reaction to the news” indicator, which is one of the better techniques used to predict price trends, is telling us that higher stock index futures prices lie ahead.

BEARISH SEASONALS ARE NOT WORKING

Late this summer, much of the media was talking about how the month of September is historically the weakest month of the year for U.S. equity prices. The record shows that this statement is correct. There was plenty of speculation that the market’s performance in September would be a repeat of last September’s disaster to the downside. One thing to keep in mind is that the seasonals, along with trading signals that are taken from chart patterns are likely not to work when they go against the fundamentals. Let’s take a look at some of the seasonals that came into play over the past few years that failed miserably. For example, the third and fourth years of a presidential term are usually up years, based on ideas that steps will be taken by the government to improve the economy and the mood of voters in advance of a presidential election.  Those seasonals did not work in 2007 and in 2008.   In addition, it should be no surprise that in the first year of a presidential term, stock index futures historically tend to underperform, because the “giveaways” in the third and fourth years of a presidential term are “taken back’ in the first and second years of the presidential term. The bearish first year of a presidential term seasonal is not working this year, most likely because it is going against the bullish fundamentals. Seasonal tendencies are not the best indicators of future price movements, except when they are in line with the fundamentals.

NORMAL YIELD CURVE

There is another indicator that is very important, but is currently underrated or totally dismissed. That is the yield curve indicator. Our research places considerable weight on the shape of the yield curve, which has a normal shape and continues to suggest that the worst of the global economic downturn is behind us. There will be further economic recovery that will gradually accelerate into next year.

A MULTI-YEAR BULL MARKET EMERGING

After a six month, virtually uninterrupted advance of around the 57% magnitude for S&P 500 futures, prices have come under some pressure in the last few days. The bears have become more vocal in their belief that we are in for a severe stock index futures correction or even that the March lows will be taken out. Throughout this six month advance in prices, it seemed as though there was never ending talk that the economy would weaken, especially after the effects of the various government stimulus plans diminish or are withdrawn. Our analysis continues to tell us that we can expect the majority of the economic and corporate earnings reports, for the balance of this year and well into next year, to be stronger than the consensus view. This will continue to support this newly emerging bull market in stock index futures, which we believe is in the early stages of a multiyear bull market. The one day reversal pattern on the daily chart from several days ago will prove to be a false sell signal and that the traders that relied on this pattern to establish short positions will ultimately be forced to cover at higher prices.

If you would like more information about this article, please contact Alan at 1.800.243.2649 or email him at alan.bush@archerfinancials.com.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff.  The information provided is designed to assist in your analysis and evaluation of the futures and options markets.  However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.