Patience Is the Name of the Game for Markets

So the atmosphere is getting downright sticky. I am getting phone calls from people who wanted to sell the kitchen sink in March and now want to buy, buy, buy. This sort of overly enthusiastic sentiment shift is exactly what prudent investors should be wary of.

Consider: despite the mammoth rally, the S&P has yet to even retrace 50% of its decline since topping out in October 2007. That level would be somewhere around 1100 on the S&P 500. A move to former support at 1200 would still keep it at 61.8% (roughly). Now, there is no question that investors trapped in the precipitous market declines of last year were better served sitting put, and strategically adding to their favorite names, rather than panicking and selling the farm. Historically speaking, there was bound to be a fairly enormous rally of some kind after such a shellacking. Take the Great Crash of the late 20's - that was followed by a 50% retracement rally. However, then, like now, required a longer period of correction before the market had truly wrung itself out.

So what do investors who weathered and perhaps even profited from this rally do now? There is a large discrepancy between taking money off the table at 900, 1000, 1100, or 1200. So investors need to come up with a strategy based on a reconfirmation of their original investment/trading rationale. Continuing to hold after declines (and then rallies) of such magnitude require a steady hand and a certain degree of daring. Traders that have minted money on this rally may well continue to do so - further shallow pullbacks and sharp short squeezes could very well mark the final stages of this move, as late-comers frantically scramble to get in on the fun.

As we speak, the investing public is making the shift to the belief that "the worst is over" and that we will emerge from this and begin - or have already embarked upon - the next great bull market. Sentiment levels like this tend to appear at market tops.

While viewers are clinging to improving production numbers there is nothing out there that I have seen yet to indicate that it is anything other than an inventory rebuilding phase, marked by putrid sales figures and rising unemployment. The government has fired its entire arsenal into rebuilding the economy and naturally we should expect some positive growth as a result... for a time. During the Great Depression, there was a near doubling of industrial production after FDR took office. We all know what happened after that. Is that what I am predicting? Absolutely not. But a short spike in GDP growth followed by a return to sub-par growth next year would qualify as a double-dip recession (or bring us close enough for my taste). The market is certainly not pricing that in.

The problem with predicting stock market action based on sentiment, contrarian instinct, or even historical precedence, is timing tends to be piss poor. As we have outlined in previous columns, the market continues to rise along the border of an elevated "broadening" or "expanding" range. This could keep going to S&P 1200 and not do any damage to the broader bear thesis. Shorts have been crushed (just as longs were crushed last fall). Stepping in front of this bus has brought nothing but pain. Even if you are correct about the eventual outcome, the difference between picking time frames can mean the difference between success and total failure.

Below are charts of the S&P 500. Draw your own conclusions.

Note the megaphone keeps getting wider. Look at that huge pocket of air beneath us. Hard to imagine a break-out move from here without even a short-term punctuation to 930 or thereabouts, but then again I have been surprised before.

The above chart looks dreadful from a longer-term perspective. And volume is declining the closer we get to those foreboding resistance levels, suggesting we are just churning higher, not bursting forward on substantive buying (high frequency trading programs anyone?).

The short & curlies of the situation are as follows: long-side traders can continue to play the frothy momentum between here and there, but they had better possess a gambler's stomach for knowing how long to press their gains. I prefer to hunt for yield in stocks or ETFs with strong consolidative patterns, good fundamentals, and a disconnect from the current economic quagmire.

Oh, and there is another winning move: do nothing. Patience is a long-forgotten virtue, but it may just be the discipline of choice as the market continues to move higher.

Comments

[justin_3d:]

Good stuff

Aug 05 06:13 PM

[TinyTim:]

Interesting commentary addressing the big question of the moment.
I'll pass on the tech analysis.

If I believe the market is being pumped up by media / govt on thin volume, what major shock is left that would cause a rebottom?

I believe the market has priced in low employment for 2-3 years, possible mild repeat GDP slowdown masqueraded by the media / govt and low durables consumption for the foreseeable future.

I attribute this rally to the impatience of a lot of cash sitting on the sidelines and the reluctance of the pros to stick their necks out.

"predicting stock market action based on sentiment, contrarian instinct, or even historical precedence"

This is what's moving the market now.
Is "do nothing" the same as "buy and hold"?

Aug 05 09:01 PM

[sethmcs:]

What's moving the market is the 82 billion in stimulus that going to hit this quarter. GDP will go positive and the recession will be declared over. Psychology will change from negative to positive. More money will chase stocks and a new bull will be declared. The dow will go to 11K and get stuck. A second oil shock will produce stagflation and we will discussing the misery index. Paul Volker will come out of retirement and I will load up on thirty treasuries yielding 15%. Until then enjoy the run up.

Aug 06 01:13 AM

[Brian Kyser:]

"Do nothing" is largely dependent on whether you're long or not, but one should not feel the need to cave in to the pressure of rushing out to buy stocks, if only because they've missed the rally. (Which is one emotion propelling the market higher). Thanks for the good comments.

On Aug 05 09:01 PM TinyTim wrote:

> Interesting commentary addressing the big question of the moment.
>
> I'll pass on the tech analysis.
>
> If I believe the market is being pumped up by media / govt on thin
> volume, what major shock is left that would cause a rebottom?
>
> I believe the market has priced in low employment for 2-3 years,
> possible mild repeat GDP slowdown masqueraded by the media / govt
> and low durables consumption for the foreseeable future.
>
> I attribute this rally to the impatience of a lot of cash sitting
> on the sidelines and the reluctance of the pros to stick their necks
> out.
>
> "predicting stock market action based on sentiment, contrarian instinct,
> or even historical precedence"
>
> This is what's moving the market now.
> Is "do nothing" the same as "buy and hold"?

Aug 06 09:23 AM

[bluesmoke:]

In the last year, I've made only 3 trades, capitalizing on low prices and preferring to "ride this out" with the remaining 95% of my portfolio. That's what long term investors do.

Aug 06 09:49 AM

[Mad Hedge F...:]

jkfkckl. Welcome to the new bubble. In four months we have gone from 35% below the 200 day moving average to 15% above. It turns out that 1,000 in the S&P 500 is 38.2% recovery of the fall from the 2007 peak, a great Fibonacci number. DeMark indicators are showing that buying power is getting exhausted. Daily sentiment indicators are 88% bullish. RSI’s and oscillators are over extended. Every day the buyers show up, marching in lockstep with military precision, to give us our needed spike up at the close to keep the rally alive on the charts one more day. Worst of all, I am getting deluged with emails from subscribers who, having stayed out all year, are asking if they should start buying now, and buying everything. All of this, and we still have the second half of the “W” to discount. If the American stock market was the only issue, I wouldn’t really care, since most of my longs are overseas. But if the US rolls over like the Bismarck, emerging markets, foreign currencies, commodities, the energies, and junk bonds will be dragged down with it, because everything is so interlinked these days. There will be no place to hide. I think the glass half full crowd is coming to the end of their run, so I would urge investors to pare down some risk. If your friends stay in, and they make a ton of money, that’s fine. Just let them buy the next round of drinks.

Aug 06 11:14 AM