Dow Jones Showing Strong Signals

We just saw the first serious correction of 9.9% in two and a half years that at least started to break the most serious uptrend levels on the downside when the S&P 500 broke below 1,860 on October 15.

But then we saw stocks rally to slight new highs in half the time it took to do the down damage. This was the strongest two-week rally in the entire bull market since March of 2009.

Welcome to the “markets on crack.”

With interest rates at zero short-term and zero adjusted for inflation long-term, speculators are having the party of their lives with the ability to leverage as high as 30 to 50 times and basically hijacking the markets courtesy of the Fed and the central banks around the world.

These highly leveraged traders and high-frequency models have moved from 15% plus of the trading volume to 50% plus. That’s a huge leap. Now, they can push up the markets on their own buying power…

Bubbles tend to absorb everything and everybody around them, they’re similar to black holes in space that are so powerful that not even light escapes… that is principle No. 7 in Chapter 5 of The Demographic Cliff.

Now these powerful traders are doing that more than ever compared to the fundamentals which are weaker than any major bubble in history. They love to keep the markets going up with endless monetary stimulus that funnels more money into stocks that have nowhere else to go due to low interest rates and falling commodity prices.

But what they love even more are the short-term swings that they play on both sides at the expense of “real” investors looking for longer term gains to meet retirement and portfolio needs.

Your loss is their gain in the short-term.

I’ve been watching for a final 7% to 10% sell-off followed by a move to slight new highs as occurred in the last top between July and October of 2007.

The last correction temporarily crossed an important line in the sand as I watched the S&P 500 break below a key trend line for the rally at 1,850 and 1,860 on October 15. Those numbers convinced me that stocks had likely finally peaked on September 19 at an S&P 500 of 2,020 and a Dow of 17,350.

At 17,350, the Dow was right at the top of the giant Megaphone patternrn top trend line I’ve been preaching about now for several months — it keeps bumping up against it and fails. Once again, it’s back there now and is already testing it at near 17,500 on November 5.

But as usual traders decided to fake everyone out with a violent correction and then slammed it into back up harder than ever. Their statement was: “Don’t consider not buying on the dips or you will lose more chips; don’t even think of going short or we will force you to abort.”

I am no longer surprised that experts across the board argue that we aren’t in a bubble. I, of course, keep arguing that this is without a doubt the greatest bubble since the tech bubble that extended from November 1994 into March of 2000.

This is an aftershock, not quite as strong as the original tech bubble, but it is equally as extreme as the broader stock bubble in indices like the Dow.

ENM Dow Bubbles

See larger image

So, let me ask you the obvious question — Does this look close to peaking or what? If it looks like a bubble, quacks like a bubble… it’s a bubble!

Stocks are now as overvalued as they were undervalued on October 15 when the S&P 500 hit as low as 1,820.

I would be most concernrned if it broke much over 17,500 on the Dow as that is where the most pronounced line in the sand is on stocks and it’s also the final level of upside resistance that has really held for months now. That’s not likely to happen near-term.

If it doesn’t happen by November 14 or so, then the trends will likely move down again… and they will probably be more extreme than last time because of the parabolic rise in the span of a few short weeks, which more often than not does suggest a bigger crash to follow.

If we’re still near 17,500 on the Dow or less by November 10 to 14, I’d say “it’s a good day to die” — to start or complete your selling process for stocks or at the very least keep trimming in your passive 401(k) and retirement plans.

Overall, I can’t predict exactly when stocks or any bubble will peak, and neither can anyone else for that matter. As far as our track record goes, we were very close with housing in late 2005 and closer still on the tech bubble peak in early 2000.

And for the record, we have been early on some and late on others. And truth be told, this one is even trickier because of the Fed-manipulated market.

In recent months, most of our shorter term indicators have already suggested we’re nearing a top. Two weren’t confirming. One of those, the advance decline line which shows more selective buying of large-cap vs. small-cap stocks, is now diverging from the new high in stocks (as long as they don’t go much higher near-term).

There is one indicator that has not confirmed a major top yet, and that is a divergence between buying power and selling pressure that finally suggests even the smart money is exiting ahead of everyone else.

But what if they don’t exit this time and they think: “The Fed has our backs, a major correction is no longer likely — so why don’t we stay in and keep jerking off other investors on the way up?”

I don’t know the answer to that one. I just keep advising to sell more on rallies and new highs like this one. This more dangerous and unprecedented “artificial” bubble looks like it is finally more likely to blow!

What I know for sure is this… the downside is way greater than the upside.

Don’t look a gift horse in the mouth.