Patience Is the Name of the Game for Markets

Includes: DIA, SPY
by: Hank Pym

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.