Will the Fed 'Cause' a Mini-Crash?

That was quite a week we just had in the market. In fact, if you are a news follower, you are probably confused as hell.

Let’s start with the Wednesday announcement of the higher-than-expected inflation numbers. Of course, almost everyone assumed the market would drop on such news. Well, as Gomer Pyle used to say, “surprise, surprise, surprise.”

Not only did the market rally, but between the higher inflation information published on Wednesday and Thursday, the market rallied 70 points in the S&P 500 (off the pre-market low in the futures). And, for those not counting, that is a 1.6% rally on stronger-than-expected inflation numbers.

When I read an article on just how bad some view this inflation data, it was no surprise when I saw the following comment:

“I am bewildered by the market’s reaction to the data from the past 2 days.”

I assume that was likely the feeling of most during those days.

Now, I want to show you what we expected as we came in last week. As you can see, we were looking for the market to rally last week to our target/resistance box.

Last week, I noted that as long as the market remained below 4515SPX, I was looking for that rally to set up a downside move.

INX 5-Min Chart

As we now know, the high struck on Thursday was 4512, and then we saw a sizeable downside move on Friday. In fact, we gave back the entire rally off the Wednesday premarket low and then some.

Yet, the interesting thing about Friday’s 1.2% decline was that it was not accompanied by any news. And, when I perused the headlines and what people were writing about the decline, it made me chuckle at how they struggled to explain it. Here is one example.

“The Dow Jones Industrial Average index fell by over 300 points on Friday after United States President Joe Biden seemingly voiced his support for the United Auto Workers union and its requests in their labor contract talks with GM, Ford and Stellantis.”

Sounds like it could make sense, right? Well, it could make sense until you looked at both GM and Ford stocks at the time this was published, as they were both in the green. Kind of a head-scratcher, huh?

Then I read the following on CNBC:

“Investors are taking a pause based on the mixed economic data that’s coming out. There was initial investor enthusiasm around inflation data coming in not too far out of expectations. On one hand, the inflation data was hotter than expected, but investors shrugged that off earlier this week thinking that the Fed would not be inclined to raise rates again next week, based on the August inflation data,” said AXS Investments’ Greg Bassuk.

“But I think having digested the additional economic data that’s come out, as well as ongoing geopolitical pressures and other developments, we’re seeing today investors pulling back and taking a breather,” Bassuk added.

Talk about mental gymnastics.

The last 3 days in the market are an exceptional example of how foolish it is to attempt to trade the market based on news. And it also highlighted just how “they are all making it up and have no idea what is going on.”

Not only did the market initially react in the exact opposite manner, which most expected based on the news published on Wednesday and Thursday, but it then dropped strongly without any news to blame on Friday.

So, I am yet again going to remind you of the wise and insightful words taken from Robert Prechter’s seminal book The Socionomic Theory of Finance (which is a book I strongly urge every single investor to read in order to better understand the market):

“Observers’ job, as they see it, is simply to identify which external events caused whatever price changes occur. When news seems to coincide sensibly with market movement, they presume a causal relationship. When news doesn’t fit, they attempt to devise a cause-and-effect structure to make it fit. When they cannot even devise a plausible way to twist the news into justifying market action, they chalk up the market moves to “psychology,” which means that, despite a plethora of news and numerous inventive ways to interpret it, their imaginations aren’t prodigious enough to concoct a credible causal story.

Most of the time it is easy for observers to believe in news causality. Financial markets fluctuate constantly, and news comes out constantly, and sometimes the two elements coincide well enough to reinforce commentators’ mental bias towards mechanical cause and effect. When news and the market fail to coincide, they shrug and disregard the inconsistency. Those operating under the mechanics paradigm in finance never seem to see or care that these glaring anomalies exist.”

There is no doubt that these last three days represent a “glaring anomaly.” And, if you intend to accept any of the mental-gymnastic-driven reasons for the action over these last three days, then you are simply fooling yourself.

At some point, one must approach the market from an intellectually honest perspective. And, when you get to that point, then you begin to recognize that what you likely have followed for many years as to what drives the market is nothing more than folly.

Now, let me blow your mind a bit more. If you look closely at the chart I presented above, not only did my projected path for the market follow through to the upside as we expected when we came into the week, but we even saw the initial move down from the resistance box to the wave I general region highlighted on my chart as well.

In other words, we were able to outline our expected path for the market without knowing or caring about any of the news that many view as being so important to market action. And I provided this path last weekend.

Now, if you look at the chart, you will see the general expectation that I have for the coming week. Ideally, I am looking for a bounce in wave ii and then for a follow-through to the downside over the coming weeks. But, since we now have the exact high in place for the potential wave 2, I am able to identify our downside targets in a more precise manner and have updated that chart to our subscribers.

Alternatively, and to keep this rather general and simple, I want to note that any break back out over 4512 before we break down below 4400SPX would open the door to rally towards the 4800SPX region sooner than I currently expect.

Moreover, should we see that downside follow through in the setup I am outlining, then it will likely be blamed upon a reaction to the Fed this coming week. But please read that quote from Robert Prechter again, and hopefully, you will not come back here and tell me that the Fed “caused” that drop. They will simply be a catalyst for a market move that is being set up.

Einstein was credited as saying that the definition of insanity is doing the same thing over and over yet expecting a different result. If you continue to follow the news or economic reports to determine the direction of the market, would that not make you insane?