Lost Momentum Triggers August Decline, Liquidity Premium Presages Rebound

Thomas Malthus may have been the founding fodder for many to declare the discipline of Economics “the dismal science” almost 2 centuries ago. The Malthusian Population Principle about animals that he applied to humans was both dismal and wildly incorrect in its assumptions. The dismal science moniker has remained as economic forecasters struggle for credibility with their “on the one hand…” crystal balls. Stock market forecasters could be even worse, accept there are so many opinions asserted that an industry has been created to discover consensus and then advise investors to do the exact opposite. Long-range economic outlooks are easier in that they allow for a great deal of variability and in the long run, who will remember what was said years before.

Short term forecasting is far more difficult, and most of the geriatric population can remember a forecast measured in days or weeks. On July 18th our report said to “expect corrective stock market beyond the late July to early August topping window. SP 4300’s is now good short-term support” As it turns out July 27th through August 1st was THE topping window that led to a 6% market decline bottoming at 4335. Even as early as June 19th our Newsletter concluded, “The Summer peak we have expected – ideally ‘late July’ – should eventually devolve into another downside scare this fall.” What allowed us to pinpoint time and price windows on the upside and downside of the market this summer were seasonal patterns, and the March Buy signals that only generated neutral sentiment readings despite the enormous 30% rally in the Nasdaq from the March lows (thank you Nvidia). Most years, July and or August witness important seasonal peaks. This year there was a yellow warning flag for traders when the Fear gage popped up to an 83% level (see chart). This was followed by an infrequent, but important momentum divergence signal when the SP closing price went to a new high while the Relative Strength Index (RSI) had a lower peak on July 28th (see chart). With our interpretation of seasonal highs due ideally on July 28th and a cycle price inflection date of August 1st that we shared (see chart), it added to our confidence that the summer correction had arrived. As soon as this August correction was underway, our charts identified a late August low near the 25th to look for an area to increase equity allocations to a portfolio. Our seasonal patterns are not a road map but a long-range weather forecast subject to new information and interpretation. There is no single tool that can guide investors perfectly and our outlook is far from 100%, but it’s interesting when there is consistency in applying one’s theory correctly in the real world.

Our forecast for a market decline into late August as a first leg was a modest pullback that failed to move experts or the public below a mundane neutral sentiment consensus. Perhaps, as the 2nd leg we expect to materialize in late September will generate more Fear. What is interesting is one of the many great charts by Sentiment Trader (sentimenttrader.com) reveals an interesting relationship between the volume of an index ETF as compared to the volume of its less liquid constituent stocks. The Liquidity Premium peaks reflect a degree of uncertainty that coincide with market bottoms and offer a lower risk entry to increase equity exposure. Over the past year recent peaks have correlated well with the end of September 2022 Bear market low (28% drop), the March 2023 banking panic bottom (9% drop) and the recent August decline low (down 6%). Historically, these rallies run a month or two before overbought conditions reach an extreme, but we will look for a move under -0.1 as the time for at least a caution flag. While our seasonal pattern favors overhead resistance near September around the 4600 area on the SP 500 Index and then risk of severe downside selling pressure, we will rely upon the technical indicators to fine tune where to fade this rally and when to add longs to the portfolio. The Bull market remains, and the short-term trend indicates more upside as well.


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