Investors' Collective Fears Point to Continued Losses

Charts Capture These Collective Thoughts & Fears: The S&P 500 is now below the critical level of 741. We should expect rallies, but they do not mean much unless we can close and hold above 741. Investors’ collective hopes and fears, along with perceptions of value and future economic activity, are captured in charts. These are the same factors (hopes, fears, and perceptions) that determine the value of financial assets.

When you understand this concept, you can appreciate the value of charts and technical analysis when making investment decisions. In the final analysis, what we at CCM “think” about the markets does not matter any more than what an individual investor may happen to "think". What does matter, and what drives assets prices is what the market collectively thinks. It did not matter that Warren Buffett thought stocks were cheap late last year – collectively, investors disagreed with him – he lost money. Ultimately, Buffett may be proven to be right, but there is no need for us to argue with the market. When the market begins to see what Mr. Buffett sees, it will show up clearly on a chart. Last week, we presented the chart below outlining the risks if support near 741 on the S&P 500 did not hold (the chart was created after the close on 2/26/09).

click to enlarge

Support did not hold and stocks dropped in two trading sessions from 752 to Monday’s intraday low of 699 (a decline of 7% in two days). The fact that major support was broken last week is not simply a break of a line on a chart. It represents investors collectively deciding the state of the economy and future economic outlook do not currently justify the S&P 500 holding above 741. The S&P 500 held above 741 for over three months, which represented the collective belief the November 2008 and 2002-2003 lows would hold. Investors no longer hold that belief. The shift in investors’ perception should not be ignored. The graph below shows a little closer view of the 2002-2008 support including the activity of the last two trading days.

On Wall Street, many money managers start their careers using a purely fundamental approach. Over time, many come to appreciate the value of technical analysis (charts). In fact, it is not unusual for fundamental managers to eventually add technical analysis to their tool kit. Some managers go so far as to abandon the fundamentals all together and focus exclusively on the technicals (not something we recommend). It should tell you something about the effectiveness of technical analysis that in my fifteen years on Wall Street, I have never seen a manager who started with a technical approach convert to a purely fundamental approach – never.

At CCM, we believe the best approach is to use both fundamental analysis and technical analysis. However, if given the choice of only using one, we would not hesitate to choose the technicals because of their usefulness in sound money management. Currently, the fundamentals remain weak. The technicals are weak too. The primary trend in stocks remains firmly down, which means the collective thoughts of investors on average are negative relative to the attractiveness of stocks. A trendline is not simply a line on a chart – it is a way to measure the current tendencies of investors – the same investors who are going to determine the value of your investments. It literally pays to understand what they are thinking and feeling. Currently, investors remain cautious and fearful. The current state of investors’ collective fear means the odds remain against those who own stocks and in favor of those who short stocks or remain defensive.

Another Weak Attempt To Calm Markets: Tuesday morning the Wall Street Journal ran a story 'Bad Bank' Funding Plan Starts to Get Fleshed Out. The timing of the government’s endless financial bailout announcements is always interesting. With all major stock markets hitting new bear market lows, we can guess recent dialogue concerning the markets in Washington went something like this:

"Mr. President, with both the November 2008 and 2002 stock market lows no longer providing support, the S&P 500 could fall rapidly toward 600. Sir, we are afraid the selling could begin to pick up significantly given the recent grim economic news and the sure to be ugly employment report due this Friday. We suggest getting some new information out about our yet to be detailed plans to deal with toxic assets. We don’t have much to release, but we can ask the reporters to use words and phrases like" (all included in the Journal’s article):

• “Filling in some of the blanks”
  
• “Considering”
  
• “No decision has been made on the final structure”
  
• “Possibly”
  
• “Many details remain unclear”
  
• “The Fed and the Obama administration also are mulling...”
  
• “The idea might not move forward.”

"Mr. President, this will give the market a reason to hope. We have to do something!"

You would think after the universally negative reaction to Treasury Secretary Geithner's much anticipated February 10, 2009 announcement the administration would realize the financial markets want details. The market needs to know the rules of the game. Tuesday's Wall Street Journal article contains very little new information and it hedges all the information with "no decision has been made on the final structure" of the plan. These vague announcements tend to generate some limited short-term interest that inevitably is followed by the same concerns about the lack of specific details.

As stated above, we should expect rallies in stocks, but they do not mean much unless we can close and hold above 741. The primary trend of investors' collective outlook for stocks remains negative.

Disclosure: Author and CCM clients have positions in SH

Comments

[pokernut:]

excellent article. thank you for posting.

Mar 04 08:52 AM

[Soham Das:]

Looks like a double top to me and Gods above save us, this is going to get murky. All supports are going to lie aside broken and the rapid sell off will start now. For any technical guy, this seems that double top is just now formed. Short the hell of out of the system, will be my call

Mar 04 10:19 AM

[OldLimey:]

A good article with which I fully agree. I also agree with the comments above. But let me play devil's advocate. Accepting that support, resistance, and trend lines can provide valuable insight into the market's collective psychology in the relatively short term - days, weeks, and months - is there not a question as to whether 12 year-old support actually means as much as the market thinks it does? Why should whatever was driving market psychology when a price level was 'toyed with' in 1997 affect how people feel today under very different circumstances? Of course, if the market today wants to believe that a level from the distant past is significant then I as a trader had better treat it as significant as well. However, whilst it's one thing looking on a trend line with greater respect as it grows older I do wonder whether we don't pay too much attention to far-distant support and resistance levels.

Mar 04 02:42 PM

[drbob66:]

"It represents investors collectively deciding the state of the economy and future economic outlook do not currently justify the S&P 500 holding above 741"

Investors? Are there any "investors" left in this market? Seems like there are only traders...short and long...battling it out on a daily basis.

Looks to me like the 700/716 levels are more critical now...although, obviously, popping back up to 741 (and holding there) in the short term would be more comforting.

Personally, I like the SPY if it gets anywhere near 602/606 (38% from from the beginning of the 1982-2007 bull market)...P/E of about 7.2 based on NORMALIZED S & P earnings. But there are PLENTY of stocks that are very attractively valued at the moment...even after today's bounce. If they were to drop significantly lower in the next few months, I'll be loading up.

Businesses WILL figure out how to negotiate the new economic landscape...it just may take a little more time.

Mar 04 08:27 PM

[MDCigan:]

Excellent article Chris! Your approach of blending fundamentals with technicals really resonates with me. Just curious, is their a valuation level where the technicals "go out the window"? S&P 400? 300? 200? Is their a valuation level where the cheapness is so extreme that trend is no longer relevant if one can just wait at least 3-5 years?

Mar 05 09:01 PM

[Conan the B...:]

MDC: At what point does Buffett's Put Play exceed the value of the entire Company if the S&P drops below 400 and his company holdings drop the same on a percentage basis?

Mar 10 03:26 PM

[MDCigan:]

Paultaut,

Not sure what Buffett has to do with this article? On the other thread, I think it has been ***REPEATEDLY*** explained to you that the puts are European style exercise and CANNOT BE EXERCISED EARLY. It is irrevelant where the S&P goes in the next 12 months. What matters is where it is 10 and 20 years from now, and if it is at 200-400 in 10 years, it means the U.S and world economy as we know it has ceased to exist, and it is time to learn to hunt and live in the wilderness.


On Mar 10 03:26 PM paultaut wrote:

> MDC: At what point does Buffett's Put Play exceed the value of the
> entire Company if the S&P drops below 400 and his company holdings
> drop the same on a percentage basis?

Mar 12 10:45 PM

[MDCigan:]

FWIW, you might read this:

seekingalpha.com/artic...

"Okay... So the $37.1 billion number we hear about as Berkshire's "exposure" is bunk. Berkshire is exposed to that number IF the value of both European, U.S. and Japanese stock markets goes to zero. A true Doomsday scenario that, should it happen, essentially means the end of all economic activity as we know it."


On Mar 10 03:26 PM paultaut wrote:

> MDC: At what point does Buffett's Put Play exceed the value of the
> entire Company if the S&P drops below 400 and his company holdings
> drop the same on a percentage basis?

Mar 13 12:03 AM