Buy the Rumor, Sell the News: The November Edition

This past week's sell off in the markets is very similar to the Q2 reporting season beginning at the end of June or the Q1 reporting period beginning in March to April. Investors are now buying the rumor of solid corporate earnings and selling the news, no matter how good it is.

This is one of the oldest and most solid rubricks of the stock market. (Why does it work? I think it is because of human psychology: rumors always originate at a time of fear and weakness in a company stock price; the news of higher earnings a period of time later will be met with satisfaction and smugness, which creates the circumstance for a price peak). Take a look at the charts in late June and early July. This is essentially a repeat performance of what we are experiencing now. But this time, the market is 15% higher than then, as it continues up its sawtooth stair pattern.

Likewise, I think we will see August and September repeated later in November and through December (the proverbial "Santa Claus Rally"). Once the current selling has run its course around 980, the market will kick back up for another 20% run higher to 1200 SP500. That is my thesis.

The dollar trade is also exacerbating this pattern. The currency traders, who are by definition speculators since there is no fundamental value behind the trade, have discovered the currency side of this equity-driven pattern. The currency trade is reinforced by the pattern of declining stock market leading to a strong dollar. This has not always been the case, but is now with all markets trading together and the US dollar as the safety trade (non-risk asset).

So, when the markets decline, they rotate to the dollar. This pushes up the dollar and gives the currency traders a big payday by betting against the stock market and for the USD. Here is the chart of the Euro - US dollar cross. Note the wild swings and their relationship to the US stock market.

So, the currency traders are adding volatility to the stock market, pushing normal buying and selling up and creating bigger market swings. This should go on for quite a while. But the fundamentals will win out, and there is nothing to indicate that the economic and business fundamentals are not getting better day by day. And the US dollar must weaken over time against other currencies unless the Fed does something completely unpredicted (and against Bernanke's past form) and raises interest rates and sops up liquidity way sooner than expected or warranted.

I am staying long this market and finding funds to reinvest at lower levels, by closing out of short positions (mostly covered calls). I expect the market to begin recovering on or about November 10. This is exactly the date when the July selloff bottomed out at 875. That was a time of great fear, but also a time to get long with a 25% up move from there to October 23.

Now, Carter Wirth just came on CNBC's Fast Money and predicted a bottom in this decline of 980 based on his chart work. That is just about right to fit the trading pattern established.

From that point, the market can go to 1200 by year end and fit the current pattern. 1200 is also the point at which the market broke down in September 2008. That is a very significant level.

After the market makes its year end top, I am in the "sideways" camp with most of 2010 moving up and down in the channel between 1000 and 1200 as the economy recovers and higher earnings eventually push stock prices out of the channel.

Comments

[logicalthought:]

>>...late June and early July... is essentially... what we are experiencing now. But this time, the market is 15% higher... as it continues up its sawtooth stair pattern... Likewise, I think we will see August and September repeated later in November and through December (the proverbial "Santa Claus Rally").<<

The reason stocks bounced from the July breakdown is that the market began to perceive that Q3 earnings would be better than Q2's. This surprised many folks (myself included) who thought that Q2 was as good as things could get based on the current environment of cost-cutting without revenue growth. If you think the market will bounce significantly from where it is now and then go on to take out the recent highs at 1100, you'd better believe that the Q4 and Q1 numbers will be significantly better than the Q3 numbers, because once the market perceives that EPS growth has flatlined, you're going to see some pretty severe multiple compression. Seeing as I'm in the latter camp, my near-term target for the S&P is around 900, predicated on 15x $60 in run-rate earnings, and I don't think things will get better than that for quite a while (although they could potentially get quite a bit worse).

Nov 01 08:18 AM

[Mad Hedge F...:]

vdr The scariest costume I saw on Halloween worn by a kid dressed as the Dow Jones Industrial Average. Listening to all of the gnashing of teeth and hand wringing after the Friday close about broken trend lines, accelerating downside volume, and crisscrossing moving averages, you would think that a time machine had just magically transported us back to the dark days of March, 2009. The volatility index (VIX) has popped from 20% to 30% in a week. Impressive. A new CNBC poll says that two thirds of investors are now expecting a “W” shaped recession, and that the next big move in the market is down. Once all of the performance chasers finally got the equity weightings they should have had last March, the market could only go down. We cut through support in the S&P 500 at 1050 like a hot knife through butter. Next stop: 980. Then hold your breath.

Nov 01 08:21 AM

[Brian McMorris:]

Exactly right. I do believe that Q4 and 2010 Q1 earnings will continue to surprise to the upside. The consensus thesis right now is the double dip recession, starting about now with weaker than expected Holiday sales. I ALWAYS bet against the consensus if I can discern one. This consensus is rock solid. It is in all the media and websites, including this one. But by the end of Q1 reporting (next May), I think the "W" idea will be completely discredited and that will make higher moves difficult until the economy shows strong evidence of recovery through much higher corporate revenues (+10% growth) and falling unemployment. That may not happen until 2011 or later.

On Nov 01 08:18 AM logicalthought wrote:

> >>...late June and early July... is essentially... what we are experiencing
> now. But this time, the market is 15% higher... as it continues up
> its sawtooth stair pattern... Likewise, I think we will see August
> and September repeated later in November and through December (the
> proverbial "Santa Claus Rally").<<
>
> The reason stocks bounced from the July breakdown is that the market
> began to perceive that Q3 earnings would be better than Q2's. This
> surprised many folks (myself included) who thought that Q2 was as
> good as things could get based on the current environment of cost-cutting
> without revenue growth. If you think the market will bounce significantly
> from where it is now and then go on to take out the recent highs
> at 1100, you'd better believe that the Q4 and Q1 numbers will be
> significantly better than the Q3 numbers, because once the market
> perceives that EPS growth has flatlined, you're going to see some
> pretty severe multiple compression. Seeing as I'm in the latter camp,
> my near-term target for the S&amp;P is around 900, predicated on
> 15x $60 in run-rate earnings, and I don't think things will get better
> than that for quite a while (although they could potentially get
> quite a bit worse).

Nov 01 02:38 PM

[Brian McMorris:]

<IMG class=authors_reply src="static.seekingalpha.co..."> Mad Hedge, I admire your consistency and hard work. You show up every day on my ;posts and many others to try and talk down the market. You must maintain a very big short book. Good for you and all the hard work you do on the other side of the trade. I benefit from all the people you convince to stay out of the market. I need that Wall of Worry. ("A new CNBC poll
says that <ul>two thirds of investors</ul> are now expecting a “W” shaped
recession, and that the next big move in the market is down"). You said it, not me. Thanks!


On Nov 01 08:21 AM Mad Hedge Fund Trader wrote:

> vdr The scariest costume I saw on Halloween worn by a kid dressed
> as the Dow Jones Industrial Average. Listening to all of the gnashing
> of teeth and hand wringing after the Friday close about broken trend
> lines, accelerating downside volume, and crisscrossing moving averages,
> you would think that a time machine had just magically transported
> us back to the dark days of March, 2009. The volatility index (VIX)
> has popped from 20% to 30% in a week. Impressive. A new CNBC poll
> says that two thirds of investors are now expecting a “W” shaped
> recession, and that the next big move in the market is down. Once
> all of the performance chasers finally got the equity weightings
> they should have had last March, the market could only go down. We
> cut through support in the S&amp;P 500 at 1050 like a hot knife through
> butter. Next stop: 980. Then hold your breath.

Nov 01 02:41 PM

[logicalthought:]

Brian,

Where do you come up with saying that "the consensus" is for a double-dip recession? That's dead wrong, in that there seems to be near-unanimity among analysts that 2010 will exhibit significantly higher earnings. Just take a look at the data right here on S&P's own web site:
www2.standardandpoors....

Specifically, I steer you to the section on that page where it says "S&P 500 Earnings (Operating, As Reported) and Estimate Report, includes Divisors and Aggregates, and Dividends, click here"

Hey, I don't want to make you feel bad, but you *are* "the consensus"!


On Nov 01 02:41 PM Brian McMorris wrote:

> <IMG class=authors_reply src="static.seekingalp...
> Mad Hedge, I admire your consistency and hard work. You show up every
> day on my ;posts and many others to try and talk down the market.
> You must maintain a very big short book. Good for you and all the
> hard work you do on the other side of the trade. I benefit from all
> the people you convince to stay out of the market. I need that Wall
> of Worry. ("A new CNBC poll
> says that <ul>two thirds of investors</ul> are now expecting a “W”
> shaped
> recession, and that the next big move in the market is down"). You
> said it, not me. Thanks!

Nov 01 04:11 PM

[Brian McMorris:]

Logical

I like that you try to use logic to arrive at your positions, but those positions require better research. "Seeming" is not enough. Analysts can arrive at the conclusion of "higher earnings" without requiring a stronger economy. They will just cynically say that there will be more layoffs to cut costs and increase earnings. Certainly, this is what the general population believes.

According to the CNN Survey at the end of August where 75% of Americans believe we are in a moderate or severe recession:
i2.cdn.turner.com/cnn/...

In another CNN poll taken October 16-18, 84% of Americans rated the economy as Poor or Very poor and getting worse.
i2.cdn.turner.com/cnn/...

CNBC's Fast Money ran a viewer (general public) poll on Thursday, October 29 where 66% of viewers expect a Double Dip or "W" recession. That is the poll Mad Hedge Fund Trader refers to above.

There are many strategists and pundits who either make the same claim of an impending Double Dip recession, or quote those who have made that claim (David Rosenberg, Peter Schiff, Gary Schilling and many others too many to name).

The fact that analysts expect 2010 earnings to rise does not indicate the consensus, except maybe of stock analysts.

I feel pretty secure in the minority camp. I will stand against the crowd as I always have.


On Nov 01 04:11 PM logicalthought wrote:

> Brian,
>
> Where do you come up with saying that "the consensus" is for a double-dip
> recession? That's dead wrong....

Nov 01 10:49 PM

[logicalthought:]

Again, I'm sorry to make you feel bad, but virtually no one believes earnings can be increased to their projected consensus (yes, consensus) 2010 levels by additional cost-cutting, and CERTAINLY no one thinks it could happen if the economy re-enters a recession. Perhaps, though, you need to see the most recent survey out there from professional economists (who are almost always wrong, as I believe you will be), so here it is:

blogs.wsj.com/economic.../


On Nov 01 10:49 PM Brian McMorris wrote:

> Logical
>
> I like that you try to use logic to arrive at your positions, but
> those positions require better research. "Seeming" is not enough.
> Analysts can arrive at the conclusion of "higher earnings" without
> requiring a stronger economy. They will just cynically say that
> there will be more layoffs to cut costs and increase earnings. Certainly,
> this is what the general population believes.
>
> According to the CNN Survey at the end of August where 75% of Americans
> believe we are in a moderate or severe recession:
> i2.cdn.turner.com/cnn/...
>
> In another CNN poll taken October 16-18, 84% of Americans rated the
> economy as Poor or Very poor and getting worse.
> i2.cdn.turner.com/cnn/...
>
> CNBC's Fast Money ran a viewer (general public) poll on Thursday,
> October 29 where 66% of viewers expect a Double Dip or "W" recession.
> That is the poll Mad Hedge Fund Trader refers to above.
>
> There are many strategists and pundits who either make the same claim
> of an impending Double Dip recession, or quote those who have made
> that claim (David Rosenberg, Peter Schiff, Gary Schilling and many
> others too many to name).
>
> The fact that analysts expect 2010 earnings to rise does not indicate
> the consensus, except maybe of stock analysts.
>
> I feel pretty secure in the minority camp. I will stand against
> the crowd as I always have.

Nov 02 06:53 AM

[Brian McMorris:]

Trust me on this Logical, you can't possibly make me "feel bad". I have a very healthy ego when it comes to the market and economic forecasts. My track record is pretty good the past 15 years, so I don't need a lot of strokes from commentors on Seeking Alpha. Still, I always like a healthy debate and appreciate your contributions.

While I am a contrarian by nature, I know which side to take on most issues. Where the economy is concerned, I don't mind being on the same side as the Federal Reserve Bank. They have more information than any of us and it is real-time, every day. One might not like their policies, but it is hard to argue with their facts. NABE surveys are also pretty hard to refute. This is not opinion. The survey is about intentions. If executives say they plan to hire, then why would one question that?

The ISM data today was very good, once again surpassing expectations. Trends are very important in economics and the trend now is up. I am not saying there is nothing that could stop it, but in investing and economics, the "Trend is Your Friend". I would add to this axiom: Fear is Your Friend. I appreciate your fear.


On Nov 02 06:53 AM logicalthought wrote:

> Again, I'm sorry to make you feel bad, but virtually no one believes
> earnings can be increased to their projected consensus (yes, consensus)

Nov 02 09:37 PM

[logicalthought:]

Brian,

Hey, you could be right. I don't think you will be (and I'm betting that you won't be), but I could certainly be wrong. The point I've been making here is that your view *is* the consensus view, so if you think that you're being a "contrarian", well, you're not.


On Nov 02 09:37 PM Brian McMorris wrote:

> Trust me on this Logical, you can't possibly make me "feel bad".
> I have a very healthy ego when it comes to the market and economic
> forecasts. My track record is pretty good the past 15 years, so
> I don't need a lot of strokes from commentors on Seeking Alpha.
> Still, I always like a healthy debate and appreciate your contributions.
>
>
> While I am a contrarian by nature, I know which side to take on most
> issues. Where the economy is concerned, I don't mind being on the
> same side as the Federal Reserve Bank. They have more information
> than any of us and it is real-time, every day. One might not like
> their policies, but it is hard to argue with their facts. NABE surveys
> are also pretty hard to refute. This is not opinion. The survey
> is about intentions. If executives say they plan to hire, then why
> would one question that?
>
> The ISM data today was very good, once again surpassing expectations.
> Trends are very important in economics and the trend now is up.
> I am not saying there is nothing that could stop it, but in investing
> and economics, the "Trend is Your Friend". I would add to this axiom:
> Fear is Your Friend. I appreciate your fear.

Nov 03 08:33 PM

[chris coonan:]

when shit hits the fan next year, the market will find a new low

Nov 08 08:21 AM