Submitted by Nic Lenoir of ICAP
The last bubble was first highlighted by the best macro traders around 2006, and it took until November 2007 to burst (high in equities) so the answer is that the market can get crazy for quite some time.
We had issued caution for bears recently because econometrics models indicate industrial production and ISM will peak around November/December and possibly at 60 (based on leading indicators such as new orders), despite our bearish conviction. We had also identified a wedge in S&P futures which could act as an ending diagonal, and would suggest we could grind higher until late october.
However the pace of the rally has picked up over the last few days we have challenged today the resistance of that possible ending diagonal (see daily chart). While ending diagonals are uncommon (see AUDUSD last year) and in this case it's a little bit of a stretch since we are in a corrective rally and ending diagonals happen usually at the conclusion of long rallies, we have other elements to add today. The 30-min chart shows we have been in a channel since 990 and we have made an excess past the resistance, which usually is a good signal we might at least test support if not that the move is exhausted. The weekly chart shows that we touched today my voodoo 88 week moving average, which could be a HUGE resistance. Also on the pit session chart we see have come back to fill the gap left open back in October, and we have a similar case with the Nikkei. The resistance on the daily wedge can also be observed on the chart of the Dax. With many indicators completely overbought, could this be the smell of a sweet reversal? Certainly selling here would make complete sense in many respects, and if the gap is fully filled around 1,102.5 then use weakness to close out the position, otherwise play 975, and then 875 on a break. Use caution and save bullets however, one is always better off adding after the downtrend is confirmed than shelling all out against the uptrend.
Keep in mind, in May 2008 there were MANY people we will not name who thought we were headed right back to the highs, so sentiment is not really prophecy and far from it in fact. This time it's different though... bears and reality are fighting the US government and its arsenal of liquidity. That's why we can have the market diverge so much while making new highs with indicators screaming "overbought". On top of it, while some time has been bought pulling the SFP bill program in order to debate the possible raise of the debt ceiling, should the Fed and the Treasury succed and have it raised we can't exclude more quantitative easing and hence more money being poured into the markets. I guess an hyperbolic collapse of the USD would then be the most likely outcome to bring back markets to reality. In the end, bonds mature, investors have to either be repaid or then default occurs, and there are a lot of maturities and mortgage resets rolling down the pipe. So given that the ISM is about to top, QE money is running out (we are below $15Bn remaining out of $300Bn or just about), and many stimulus programs are running as well, headwinds could start being felt again. Barring more US government intervention it is likely that recent exhuberance will come to an end sooner rather than later. However as always one must remain cautious because these days capital markets are a mere reflection of government action... as long as government remains unchallenged.
Good luck trading,