The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (
) -- Reports this past week showed that the unemployment rate in the U.S. was improving markedly.
In addition, sentiment numbers confirmed my speculation that market participants were becoming more and more bullish as the
edged higher. In fact, sentiment hasn't been so bullish since Feb. 11, 2011.
The table below illustrates the most recent sentiment survey.
The current bullishness is interesting considering the notable headwinds that exist in the European sovereign debt markets, the geopolitical risk seen in light sweet crude oil futures, and the potential for a recession in Europe.
Source: the American Association of Individual Investors
To further illustrate the complacency in the S&P 500, see the daily chart of the Volatility Index below.
The VIX has been falling for several weeks and is on the verge of making new lows this week. If the index works down into the 16 to 18 range, a low-risk entry to get long volatility may present itself. For options traders, when the VIX is at current levels or lower there are potentially significant risks associated with increases in volatility.
My expectations have not changed considerably since last week. However, I continue to believe that the bulls will push prices higher in what I believe could be the mother of all bull traps. Let me explain. As shown above, we have strong bullish sentiment among market participants paired with general complacency regarding risk assets.
As I pointed out last week, my expectation is for the S&P 500 to top somewhere between 1292 and 1325. A lot of capital is sitting on the sidelines presently, and if prices continue to work higher I suspect that a move above the 1292 price level will trigger a lot of long entries back into stocks or other risk assets.
We could see prices extend higher while the "smart" money sells into the rally. Retail investors and traders will point to the inverse head-and-shoulders pattern on the daily chart of the S&P 500 and the breakout above the key 1292 price level. The pervasive fear of missing a strong move higher will help fuel long entries from retail investors.
At the same time retail investors begin buying, a lot of committed shorts will be stopped out if prices push significantly above the 1292 area or higher toward the more the obvious 1300 level. Thus, there will be few shorts to help support prices should a failed breakout transpire. A perfect storm could essentially develop: a lack of shorts to hold prices higher combined with a trapping of bullish latecomers.
The daily chart of the S&P 500 Index below illustrates what I expect to take place in the next few weeks.
I want to reiterate to readers that it is not totally out of the question that the 1292 price level could hold as resistance or that we could roll over early this coming week. Additionally a breakout to more than 1330 will certainly lead to a test of the 2011 highs around 1370.
If the S&P 500 pushes above the 1370 area we could witness a strong bull market play out. Ask yourself this question, what reasons could produce such a rally and what are the probabilities of that outcome in the next few weeks?
Obviously, earnings season is going to be upon us shortly, and if earnings come in below expectations a potential selloff could intensify. Furthermore, economic data in Europe continue to weaken, and slower growth appears to be manifesting within the core eurozone countries like Germany and France. If most of Europe plunges into a recession, deficits will widen beyond economic forecasts and the strain in the eurozone sovereign debt market will increase dramatically.
One key element that many analysts are not even discussing is the potential for higher oil prices to present additional economic headwinds for developed Western economies.
Clearly the situation in the Middle East is unstable, specifically what we are seeing taking place in the Strait of Hormuz involving Iran. If a "black swan" event occurs such as a military conflict between the U.S. and Iran or Israel and Iran, the prices of oil will surge.
In a recent research piece put out by SocGen, nearly every scenario that is referenced involves significantly higher oil prices. According to the report, the eurozone is considering the banning of imported Iranian oil, which SocGen contends could cause Brent crude oil prices to surge to a range of $120 to $150 a barrel.
The other scenario involves the complete shutdown of the Strait of Hormuz by Iran. If this shutdown were to persist for several days, SocGen estimates Brent crude oil prices would rise to $150 to $200 a barrel.
Clearly, if either of these two scenarios plays out in real time, the impact that higher oil prices will have on European and U.S. economies could be catastrophic.
The daily chart of light sweet crude oil futures is shown below.
I want readers to note that I am not suggesting that oil prices are going to rise or fall. I'm just outlining where SocGen expects oil prices to go should either of the two scenarios presented above play out. If oil prices were to work to $125 a barrel and remain there for a period of time, I would anticipate a very sharp decline in the S&P 500.
Currently there are a lot of headwinds for bulls, some of which could persist for quite some time. I intend to remain objective and focus on collecting time premium as a primary profit engine for my service at
Once I see a confirmed move in either direction I will get involved. For now, I intend to let others do the heavy lifting until a low-risk, high probability trade setup presents itself. Risk is increasingly high.
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