BARN BURNER - Thankfully, a trading week in the market is five days. I said in my Monday preview commentary things could really heat up this week. But Monday was an absolute joke. Of the markets I watch, CAD was the rocking outperformer, closing up a staggering 0.13% on the day, while GOLD lost its nerve and collapsed, to close 0.24% lower. Elsewhere, US equities disappointed again, showing no ability to confidently follow through to the downside, with the market giving back declines to settle marginally higher. I have said that the equity market is the key market to watch given it's unsettling correlation with Fed policy. While other markets have done other things over the past several months, US equities refuse to do anything but trade higher on an expectation that the Fed will continue to incentivize reckless investment.
REMEMBER THIS - The stock market is like a spoiled child that simply won't have it any other way. By extension, this of course also means bad parenting from the Fed. Now I can't say the equity market is going to roll over today or tomorrow, and it would be foolish for me to come out and call for such a thing given how unrelenting this rally has been. But remember this. The Yen was trading at cyclical highs against the US Dollar in 2012 and there weren't too many out there calling for a reversal. The Australian Dollar was tracking towards 1.1000 against the US Dollar and the idea of the currency declining was absurd. The Canadian Dollar was never expected to sell-off as it did after breaking parity against the Buck. And yet, all of these markets have undergone such intense reversals that very few remember that they were ever so bid.
THE FIVE MINUTE TEST- I believe we are now seeing this play out with the New Zealand Dollar, and there are plenty of other examples where such reversals have occurred. So to sit back and doubt whether we will see such a reversal in US equities is a ridiculous notion. Not too long ago, there were many out there attributing equity gains to valuations. This has pretty much gone out the window and everyone pretty much agrees the rally in stocks is primarily driven on Fed incentive. So we will see a correction, and the correction will be more than 2%. If you pull up a monthly SPX chart and then look at it as if it is a five minute chart, you will get an idea of what a minor correction could be without even compromising the uptrend. Just think of the monthly as a five minute chart and pick a spot with your finger where that five minute chart could easily drop to. Does 1800-50 seem crazy? Not really.
LEANING A LITTLE TOO HARD - I have also been thinking a lot about what this reversal will mean for bulls when it actually plays out. While it is true bulls have been in the driver's seat for as long as we can remember, perhaps there is a danger in this. You see, each and every time the market drops even the slightest, there is a surge in bids driving stocks to fresh highs. Bulls are no longer worried about pullbacks as they have come to trust this pattern. So when we finally do see a drop, bulls will initially just expect the fresh buying to reemerge. And when it doesn't, they will wait some more, knowing full well the buying will return a little lower down. This 1-2% correction will then turn into 5-6% rather quickly, and at that point, you will start to see a bit of panic selling from bulls. There will be some serious profit taking that kicks in, and from there, we could easily expect to see another 5-10%.
THE BIGGER THEY COME - And guess what, even when we do see such a correction, we will still be trading above the record highs that were set in 2013. So let the market try and push higher. This will only increase the likelihood of a more severe drop when it plays out. You go ahead and take another look at that monthly chart and tell me what you think. Do you like the idea of buying that chart? Does that chart look like a normal, healthy market that the Fed should dismiss as reasonably priced? I really don't think so. But you won't hear that from Janet Yellen, as she knows full well that if she truly expresses concern over what Fed policy has done to equity markets, it will completely undermine the Fed's recovery strategy. I want to be clear. I think the Fed has done what they have needed to do and believe there is plenty of merit to the strategy. At the same time, there are plenty of holes right now, and we have reached the point where these holes need to be dealt with.....urgently.