Need to Ride the Bear to Get to the Bull

Includes: DIA, QQQ, SPY
by: Philip Davis

Markets run in cycles and we have to let go of this bull cycle and ride out a bear cycle, in order to get to the next bull cycle. The government, the media and the Fed have, for the past year, been trying to change the ordinary course of things by pretending we can just skip from one bull market to another bull market without all that messy correction in between. Its simply not healthy. The 5 stages of grieving are Denial (we went through 2 years of that in housing), Anger (who hasn’t been blamed for this now?), Bargaining (Cramer et al screaming for Fed intervention), Depression and Acceptance. The last two parts we keep skipping as every time the depression (a bear run) starts, the bulls ratchet up the bargaining and the Fed or the Government cave in and "rescue" the bulls.

Any good psychiatrist will tell you that avoiding these last 2 stages of grief will only lead to a much worse situation down the road as the refusal to face the depression and accept the situation can lead to an endless string of bad decisions as we are unprepared to move on in a realistic fashion (see "Psycho" for the end result of refusing to accept a loss).

The market moved from yesterday’s depression right back to bargaining (the new Fed "deal") demand jumped right back to denial again this morning BUT THE LOSS WAS STILL THERE! When your mother is dead, sticking her corpse in a rocking chair and putting on a wig and her clothes is NOT going to mean everything is fine (and if you haven’t seen Psycho then that probably sounded pretty crazy!). Sooner or later someone will drop by and ask about your Mom (in this case, the hundreds of billions of financial losses) and you can’t just stab them all in the shower.

OK - perhaps we’ve stretched the analogy here but the value of your stocks, especially your options to buy stocks, is based on future performance expectations and uncertainty is not a neutral event. You have to look at the likelihood of conditions improving vs. the price you are paying for a security (funny word as they are anything but) and this ridiculous notion that the market can OR SHOULD go up constantly is very detrimental. If all the people who had ever been born never died, where would you live? The same goes for companies - everything has a season yadda yadda…

Anyway, we had a totally fabulous day as we didn’t buy the rally from the outset. At 9:31, with the Dow opening at 13,569 my opening statement to members was: "I’m not doing anything in general - sometimes you have to take a hit, take a breath and then come up with a rational course of action. Let’s see what levels we get to before buying into this. I’m not sure how much this really helps anything other than giving the bulls an excuse to rally. The CB’s have been giving money out like candy anyway, this is just more of the same but we’re not going to fight the tape."

Just 18 minutes later, the Dow 100 points higher, after having peaked at 13,700, someone asked me if we should consider taking on new LTP positions and I said: "LTP - I’d wait a bit for a real dip. 13,700 is so close to the top of the year’s trading range that you are much more likely to be overpaying than underpaying. I’m tempted to short here actually but I’ll just be happy if this lunacy calms down here. I’m really getting fed up but S&P 1,505 is nothing to rally about and all I see is a ton of blocks being sold to retail investors who think $40Bn tossed out by the CBs is going to solve something. If they Dow breaks back below 13,600, we can probably short anything we wished we shorted yesterday, like XOM, which is now up over yesterday’s high and very close to it’s 10/29 high of $93.61 (spike to $94.27). At that point, out of principal, I will have to bet the farm on XOM going down! If you are long, I would suggest exiting with the big boys and just being happy you got out of yesterday’s mess with little damage. Let’s wait for a real breakout before we start “bargain hunting.” If you are short, I would roll up to Jan puts but you have to assume Dec is dead as we only have 8 sessions left."

This is essentially following my "Don’t just do something, stand there" policy of crisis management that has served us well in several sharp corrections this year. After that very excellent top call we not only held onto but improved our short positions, cashed out our longs and generally had a really good time playing stock market roulette as the Dow dipped back to my 13,000 to 13,300 trading range after a pointless 5-day, 500-point diversion.