back to normal long positions

As you can see from the daily bar chart above the cash S&P 500 has reached new highs for the bull market that started in March 2009 from the 666 level.

The aggressive contrarian trader has maintained an above average long position established at the 690 level. According to the rules set out in chapter 11 of my book the aggressive contrarian should have sold his long position when the 50 day moving average of the S&P turned lower by 1/2 % in mid-May of 2010. But by then the S&P itself was in a position where I thought the aggressive contrarian should be a buyer. I said so in this post and again in this one. So the net result was that the aggressive contrarian would have held his above average long position throughout the April-July 2010 drop.

Now that the S&P is back at new bull market highs and has rallied more than 20% from its early July low I think the aggressive contrarian should cut back his above average long position to average levels. I would not reduce exposure more than this because I think that the S&P has quite a bit further to go on the upside over the next six months.

The conservative contrarian established an above average long position around the S&P 1000 level as I pointed out in this post. As I write this the S&P has rallied for 20 months from its March 2009 low and has advanced 82% during that time. According to my tabulations (which were described in my book) this qualifies as a normal bull market both in duration and in extent. So the conservative contrarian should now reduce his stock market exposure to normal levels too.

bond frenzy redux

Yesterday the Federal Reserve announced its latest program of "quantitative easing", a program that had been well anticipated by the stock and bond markets. The Fed is going to be a big buyer of treasury bonds and notes over the next 12 months. Today's front page of the New York Times has as its headline story the Fed announcement.

As I pointed out in my last post on this subject a couple of weeks ago, the bond market is in a "frenzy" stage. The chart above shows that 10 year note yields are near their historical low points. In fact,the last two front page stories on the bond market have both occurred while the 10 year note yield has hovered above its recent lows and above its historical low of 2.02% reached in December 2008.

I take this as evidence that the market thinks the Fed will succeed in its goal of fostering an economic recovery. The implication is that bond yields are headed much higher from here.

Interest rates headed up

Just above this post you see an image of the October 26, 2010 edition of the New York Times. Just above the fold on the left side of the page you will find the heading "Bond Frenzy: Investors bet on inflation". The NYT reports that in the latest auction of 5 year, inflation protected, treasury notes investors paid the treasury 55 basis points per year for the privilege of loaning the treasury money!

According to the Times the auction results tell us that investors fear inflation but I do not agree. If they did ordinary, non-inflation protected note yields would be high. But as you can see from the top chart of weekly 10 year note yields this is not the case. In fact, the yield on 10 year treasury notes is very near historically low levels. A different way to see this is to compare the inflation protected yield with the yield on ordinary 5 year notes. This spread, currently less than 2.00%, is the market's best estimate of likely annual inflation for the next five years. No expectation of inflation there!

But as a contrarian I think the NYT use of the term frenzy to describe bond investors' mass behavior is spot on. In this previous post I observed that mutual fund investors were pouring money into bond market mutual funds and taking it out of stock market mutual funds at a record pace. That hasn't changed during the past couple of months. Nowadays people brag about their bond portfolios like they used to brag about the skyrocketing value of their homes or the pile of money they made on the latest dot.com offering.

Nearly two years ago I predicted that the bull market in bonds and the long drop in yields that began in 1981 was just about over. I haven't changed my mind. And the prospect of further quantitative easing by the Fed just reinforces my view. Bond yields are heading much higher from here.

The Worst is Over

At the top of this post is an image of the cover of the latest issue of Time Magazine. The chart below the Time cover is a monthly chart of the housing stock index quoted on the Philadelphia stock exchange.

The historical low of the index was reached in March 2009, coincident with the low in the S&P 500. While the S&P 500 is currently trading about 30% below its all time high, the housing index stands 70% below its all time high and much closer to its all time low than the S&P.

The Time cover together with the fact that the housing index is still near the low of its historical range suggests to me that the worst is over for housing stocks. I doubt we shall see a return to all time highs in the index any time soon, but neither do I think the 2009 low will be taken out.

The important point here is that if the housing market in the U.S. can stabilize and recover, then the entire economy will get an extra upward push. This in turn will help lift the gloom that seems to have engulfed the the U.S.A. As the dark clouds begin to disperse the stock market will rally. I still think the S&P 500 is headed for 1300 and above over the next nine months.

Investors Flee Stock Market

At the top of this post you will find an image of Sunday's front page of The New York Times. I did a double take when I saw the headline: "In a striking shift investors flee stock market".

Underneath the front page image I have posted a chart showing monthly inflows and outflows to and from U.S. stock market (red bars) and bond market (gray bars) mutual funds.

Two things stand out on this chart.

First, money is flowing out of stock market mutual funds - a very unusual development. On a monthly basis it looks to me that outflows during the past three months have been greater than for any three month period since the March 2009 low. This is not surprising since the April-July drop in 2010 was twice as big as any other drop since March 2009.

Of course we already know that there is widespread bearish sentiment about the U.S. stock market. This information and the Times headline just confirms this judgment. It gives me confidence that the next big move in stocks from here will be upward.

Second, there has been an enormous inflow of money to bond funds. Since bond yields are at or near their historical low points I take this as a sign that an enormous bullish crowd (on bond prices, not yields!) has built up. I think this bond market crowd is similar to the stock market crowd that existed near the 2000 top in the stock market's internet boom. And I also think that we are very near the point where this bond market crowd will begin to disintegrate, thus sending yields higher and prices lower. I don't think we shall see U.S. bond yields this low again in our lifetimes.

Wheat

Friday morning my attention was caught by the headline you see above in the image of the front page of the New York Times: "Russia, crippled by drought, bans export of grain". On the surface this would seem to be bullish news for wheat prices. But notice how wheat traded on Friday on the Chicago Board of Trade - the market broke nearly 60 cents from its high of 815 the previous day. Someone took advantage of the buying this headline encouraged to sell a lot of wheat!

The real question from the contrarian trader's point of view is whether or not a big bullish crowd in wheat has developed. My answer to this question is no. Why? Take a look at the weekly wheat chart above this post. You can see that wheat is trading at roughly the midpoint of its historical range. Moreover, the recent wheat bull market has lasted only about 8 weeks, barely enough time to attract the public's attention.

So I think this headline marks only a temporary top in wheat. I see support in the 675-700 range and think the market is likely to move higher from there.

Cocoa

The image at the top of this post is the front page of Sunday's New York Times. At the lower left you will find a story about a hedge fund that apparently has "cornered" the cocoa market. In other words, the fund has bought so much cocoa that any further buying by anyone, in particular by shorts wanting to cover their positions, will send the price way up.

This is the sort of bullish story that you will find when a market is trading at or near its historical high point. Cocoa is in this case no exception to this rule. The monthly bar chart above shows the last 15 years of trading in cocoa futures and indeed the market is trading only a little below its historical high point.

The market cynic might ask why a hedge fund would want it known that it holds an enormous long position in a market and has it cornered. My answer is that that fund wants to sell its position. It wants to scare the shorts into covering and encourage new long positions by people who think this "corner" will push the market much higher.

I conclude that cocoa prices will be a lot lower 12 months from now.

Times and Tribune Tidbits

Here is the latest from weekend editions of The New York Times and the Chicago Tribune. I think these items are more evidence (as if we needed any) of the generally bearish views of the investing public.

The image immediately above this post is the front page of Saturday's Times. Stock market volatility is mentioned in the sub-head. In the story itself the recent stock market drop is offered as one explanation for rich people becoming more frugal. As headlines go this one is not a particularly strong indicator of bearish sentiment on a stand-alone basis. But in the context of the bearish drumbeat of the past two months it serves to reinforce my conclusion that bearish sentiment is still strong - not surprising since the low was made less than three weeks ago.

The middle item is the first part of a story in the business section of yesterday's Sunday Times. Jeremy Siegel, a long term stock market bull, was interviewed about his market prognosis. What I find interesting about the headline is the suggestion that "heading for the hills" is the natural investor reaction to the recent market drop.

Finally, the image at the top of this post comes from the business section in the Sunday edition of the Chicago Tribune. Such a strong reaction to Friday's drop is again evidence that a strong bearish crowd has developed over the past three months.

All in all I think that the bearish sentiment is strong enough to support an advance in the S&P 500 to the 1300 level and above over the next 8 months.

Small Investors Flee Stocks

The image immediately above this text appears on page 1 of today's Wall Street Journal. The graph within this clipping depicts the net weekly inflows into mutual funds which invest in the U.S. stock market. The latest downward red spike in this graph shows a greater outflow than in any week since the bear market ended in March 2009. One can infer from these data that small investors are quite pessimistic about the prospects for the U.S. stock market.

The chart at the top of this post comes courtesy of StockCharts.com. It shows the results of the weekly investors survey conducted by the American Association of Individual Investors. The latest reading shows the greatest percentage of bearish opinions since the March 2009 low.

These data show that the actions and expectations of small investors are in sync to the bearish side. The extent of bearishness is comparable to that seen at the March 2009 low point. I can only conclude that the bull market that began then is still underway and that the S&P has started an advance that will take it well above the 1300 level.

NYT highlights the bears

In the Business section of the July 4, Sunday New York Times there were two profiles of prominent market and economic pessimists.

Rogoff and Reinhart are two economists who collaborated on a book "This Time is Different" which recounts the history of financial crises over the past 800 years. Judging from their public statements they think that the consequences of the 2008-09 financial crisis will be serious and long lasting. The Times profiled them on the front page of the business section.

The fellow whose picture is at the top of this post needs no introduction. He is Robert Prechter of the Elliott Wave Theorist. He has been a vocal, long term bear on the world stock markets and the world economy for years. This story appeared inside the business section.

I think one can infer from this that the NYT business section editors believed that the thoughts of two prominent bears on the economy would be of interest to its readers on July 4. The media are in the business of telling people what they want to hear. So I take these two stories as more evidence highlighting the strength of a bearish investment crowd which has grown quickly during the current 15% drop in the averages. I think the next big move in stock prices from current levels will be upward.

Da Bears

Here is the cover of the latest issue of Businessweek magazine. The cover story tells us that the perma-bears who called the crash of 2008 may be about to have their day once more.

I have found that when the news media highlight the views of of money managers or market gurus those views are about to be proven wrong by subsequent market actions.

I think this cover story is another piece of evidence that the current market juncture (S&P 500 closed yesterday at 1087) is a big buying opportunity for the aggressive contrarian trader. Of course aggressive contrarians who have been following this blog and the methods of my book are carrying an above average long position from the S&P 690 level for more than a year now. So for them no additional action is called for.

Blood in the water?

Here is the cover of The Economist's latest issue. It shows a "Jaws"- like image of a shark's dorsal fin peeking above the water. This image screams "hidden danger" and the caption, in bold red letters, is "Fear Returns".

I think this image reflects the sudden return to strong bearish sentiment that has been induced by the U.S. stock market's 15% drop in May. It also reinforces the reluctance of the average investor to "get back in the water". So I think it is a strong positive portent of the market's future direction from current levels (Friday's S&P 500 close was 1089).

Along the same lines I want to bring to your attention the latest weekly sentiment survey of the American Association of Individual Investors. It shows 50% of those responding expressing bearish views about the near term direction of the market, the highest level in more than six months. It is unusual to see more than 50% bears in this survey since the AAII members tend to be generally bullish on stock prices.

All in all, I think the current market juncture is a buying opportunity for the aggressive contrarian trader. But since he already is carrying an above average stock market commitment from the 690 level in the S&P 500 no further action is required.

Green light from Jay

For the fourth consecutive night Jay Leno did a comedy riff on the scary state of the stock market during his opening monologue on "The Tonight Show". This is very unusual. I think Jay is mirroring substantial popular angst over the stock market's recent 15% drop.

Current levels (yesterday the cash S&P 500 closed at 1068) will look cheap six months from now. This is a buying opportunity for the aggressive contrarian trader. But since he still has an above average long position carried from 690 on the S&P last year no action is required.

Buy the Euro

Paolo just brought to my attention the latest over story of Newsweek's Atlantic edition dated May 17. The cover story was written by Niall Ferguson, a leading economic gloom-and-doomer.

The tenor of the article is well described by the cover caption "The End of the Euro" although Ferguson, like any good prognosticator, hedges his view. Nonetheless, I take this cover story as good reason for thinking that the drop in the Euro from its recent high near 1.50 is about to reverse. This magazine cover just reinforces the emotions which are reflected and amplified by the drumbeat of newspaper and website headlines about the financial crisis in Greece.

The monthly chart at the top of this post shows the Euro going back 15 years or so. I think the currency has been trading in long term boxes that are about 40 cents from top to bottom. The top box has its low near 1.21 My best guess is that after trading sideways to lower for the next month or so the Euro will rally at least half way back into its box. That would put it back at 1.40 or a bit higher.

More evidence...

... that an important low was established at 1056 last week.

On Saturday, May 8, the New York Times again had a stock market headline. That made it two consecutive days, the first time this has happened since the March 6, 2009 low when two consecutive stock market headlines occurred just a day before that low. Then on Sunday the Times' headline was about the Greek contagion spreading to the U.S. and the rest of the world. The story inside the paper quoted several people, notably Bill Gross of Pimco, who remarked how the fear that had overcome investors had changed the bullish situation into a bearish one.

Finally, Friday night's Tonight Show with Jay Leno had Jay doing a long riff of jokes on Black Thursday's stock market crash.

This is yet more evidence that Black Thursday was a big buying opportunity for the contrarian investor. I think the cash S&P is now headed for 1300.

Black Thursday - a buying opportunity

By now you all have probably heard of yesterday's stock market fireworks in the U.S. markets. At around 2:20 pm the S&P started a hair-raising plunge that took the average down 7% in 30 minutes. The cash S&P 500 hit a low of 1065. Then the market pulled a dramatic U-turn and rallied 7% in the next 30 minutes, recovering nearly all of its losses. Nonetheless, this average closed down on the day by more than 3% from Wednesday's close.

What's next?

I think the situation now is very similar to the one that developed in early February. Take a look at the top chart. You can see that at yesterday's low the cash S&P 500 was trading a little below its rising 200 day moving average and a lot below its rising 50 day moving average. This is a classic buying opportunity for the aggressive contrarian as I explained in chapter 11 of my book.

Today's headline in the New York Times (image of today's front page is above) confirms this. This is the first time since the February low that the stock market has received a bearish headline mention in the Times.

Since the aggressive contrarian has maintained an above average commitment to the stock market from the 690 level in March of 2009 no additional action is called for. I think yesterday's Black Thursday will appear in retrospect as a huge buying opportunity. I expect the S&P to trade over the 1300 level during the next several months.

The Depths of Pessimism

Here is a chart that appeared in Saturday's edition of The New York Times. It covers more than 40 years and shows the difference between the percentage of Americans who expect their income to rise during the next six months and the percentage who expect their income to fall during that time.

I think this chart is interesting because it confirms the deductions I had made from the material in my media diaries during the past few years.

First of all, this survey data shows the level of economic pessimism reached during 2009 was more extreme (by a wide margin) than any during the past 40 years. This is consistent with the story told by magazine covers and newspaper headlines during 2008 and early 2009. During that time I often remarked that the torrent of pessimism was more extreme than any I had observed in my forty years of market experience.

Second, the five year bull market of 2002-2007 was associated with a lower level of of optimism than any similar bull market/economic expansion during the previous 40 years. This too was apparent in the stream of media commentary that accompanied the bull market. At the time I was astonished at how many investors refused to participate in the long bull swing.

This chart also is another piece of evidence suggesting that the 2009 low point in stock prices was a once-in-a-generation low. I doubt we shall see levels of pessimism like those of early 2009 anytime during the next 30 years.

Always darkest before the dawn

I thought you might find this (slightly edited) excerpt from a Time Magazine article interesting:

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IF AMERICA'S ECONOMIC LANDSCAPE seems suddenly alien and hostile to many citizens, there is good reason: they have never seen anything like it. Nothing in memory has prepared consumers for such turbulent, epochal change, the sort of upheaval that happens once in 50 years. That may explain why so many voter polls, taken as the economy shudders toward the November election, reveal such ragged emotional edges, so much fear and misgiving. Even the economists do not have a name for the present condition, though one has described it as "suspended animation" and "never-never land."

The outward sign of the change is an economy that stubbornly refuses to recover from the recession. In a normal rebound, Americans would be witnessing a flurry of hiring, new investment and lending, and buoyant growth. But the U.S. economy remains almost comatose. Unemployment is still high; real wages are declining. At a TIME economic forum last week, forecasters predicted that U.S. growth would amount to half the speed of a normal recovery. The current slump already ranks as the longest period of sustained weakness since the Great Depression.

That was the last time the economy staggered under as many "structural" burdens, as opposed to the familiar "cyclical" problems that create temporary recessions once or twice a decade. The structural faults represent once-in-a-lifetime dislocations that will take years to work out. Among them: the job drought, the debt hangover, the banking collapse, the real estate depression, the health-care cost explosion and the runaway federal deficit. "This is a sick economy that won't respond to traditional remedies," said Norman Robertson, chief economist at Pittsburgh's Mellon Bank. "There's going to be a lot of trauma before it's over."

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By the way, the article appeared in the September 28,1992 issue of Time. Thanks to Professor Mark Perry for the link.

America is back!

Here is the cover of the latest issue of Newsweek magazine. Does it have any significance for the contrarian trader?

In my book I emphasized that the goals of the contrarian trader are to identify stock market crowds as they form and to determine the point at which the crowd begins to disintegrate. I think this cover shows that the extreme bearish sentiment among stock market traders and investors that prevailed only 12 months ago has begun to lift. The bearish crowd of a year ago is well along the path to disintegration. And a bullish crowd may well be forming.

But if a bullish crowd is forming it still has a long way to go before its views dominate the U.S. stock market. This cover is one of the very first significant instances where main stream media are showing more optimism about the U.S. economy. I think economic optimism will eventually translate into stock market optimism (but note this cover doesn't mention the stock market explicitly).

So I conclude that if anything this cover is a buy signal for investors. It shows that a bullish stock market crowd is beginning to form but is still in its youthful stage. As the crowd matures stock prices will go higher. Near the bull market top I expect to see many more positive stories about the economy, and several stories about how well stock market investors are doing.

Apple Bubble

A pair of the latest magazine cover stories has caught the eye of Paul Montgomery, today's foremost practitioner of contrary opinion technique and the inventor of the magazine cover indicator. (You can read more about Paul on page 212 of my book.)

Above this post you can see images of the latest covers of Time magazine and Newsweek. They feature Steve Jobs and his latest product, the i-Pad. From his research on magazine covers Montgomery discovered that the appearance of a CEO or his company's product on the cover of a general interest newsweekly like Time or Newsweek is often associated with an important high or low in the company's stock. I discuss this magazine cover indicator on pages 92-95 of my book.

As you can see from its monthly bar chart Apple Computer (AAPL) has nearly tripled in price over the past year. It has been one of the leaders of the current bull market. But the two magazine covers above are warning us that public enthusiasm for Apple Computer has reached bubble levels. Montgomery has found that in this sort of circumstance the final high of the company's stock price follows the publication of the cover stories by about 4 months on average. On this basis we should expect AAPL to move higher for the next 3 or 4 months. But 12 months from now it is very likely that AAPL will be selling substantially lower that it is now.

The Sweet Spot

At the top of this post you will find an image of the business section front page from today's New York Times. Six months of relative stability in crude oil prices (red oval) has attracted the attention of the Times. I'm sure a lot of people have noticed this, but I think the situation is about to change.

One of my primary reasons is that oil competes with natural gas in power generation. And recent technological advances in natural gas extraction technique have vastly expanded the amount of recoverable gas supplies the word over. This dramatic shift in supply conditions has made itself felt in the natural gas market (middle chart). I think a big drop in oil prices lies dead ahead. I think crude will drop below the $30 level.

Mutual fund flight

Here are two charts which appeared in today's "Abreast of the Market" column in the Wall Street Journal. The bottom chart shows the cumulative money flow into U.S. stock market mutual funds (pink graph) and into foreign stock market mutual funds (blue graph). As you can see investors have been pulling substantial amounts of cash out of mutual funds that invest in U.S. stocks and putting that much and more into foreign stock market mutual funds.

It is quite unusual to see such a prolonged outflow from U.S. stock market mutual funds. This is yet another piece of evidence that global investors are generally bearish on U.S. stock prices. And it tells me that the bull market that began in March of 2009 has much further to go.

The fact that there has been such a substantial inflow into foreign stock market funds by global investors I see as evidence that these investors are bearish on the U.S. dollar. I take this to be more support for my contention that the dollar has begun a new bull market which will carry the US dollar index to the 100 level.

Finally, the top chart above this post shows shows enormous inflows into various U.S. bond market sectors. This contrasts with the outflows from the U.S. stock market. Apparently investors who want to invest in the U.S. markets think that bonds are a better bet than stocks. This is a piece of evidence which supports my view that the U.S. and global bond markets have begun a multi-decade trend towards lower prices and higher yields.

Building the Wall of Worry

Here are the latest covers of Newsweek and The Economist. How do they make you feel?

Do these covers make you want to increase your exposure to the stock market?

Probably not. That's why I see them as the latest bricks laid atop the wall of worry. The more bricks the media lay on the wall, the higher stock prices can climb.

Buying opportunity

If you have read my book and been following this blog you know that the aggressive contrarian trader purchased an above-normal long position near the 690 level in the S&P near the March 2009 low. The aggressive contrarian is still holding this position. More than 9 months have passed since the low. So now he is waiting for the 50 day moving average to turn down by 1% from its recent high near the 1114 level (blue line in the chart above). According to the trading strategy for the aggressive contrarian that was discussed in my book's chapter 11 such a turn down in the moving average would cause him to sell his entire long position.

However, in the current situation I think that even if the 50 moving average does turn down by 1% the aggressive contrarian should stick with his above-average long position and not sell it. Here's why.

For the first time since the March 2009 low point the stock market was mentioned in a New York Times headline - see the image above of the February 5, 2010 front page. The headline shows a moderate but not extreme amount of bearish sentiment, about what you would expect from a decline that has lasted only 3 weeks. For many examples and a thorough discussion of extremely bearish setiment in newspaper headlines read my book.

The fact that this headline appeared on the day that the market matched the length in percentage terms of the previous biggest drop within the up swing from the March 2009 low makes the headline doubly significant as a buying opportunity. Finally note that the market has dropped well below its 50 day moving average, and at Friday's low was just 2% above its 200 day moving average.

This combination of circumstances is a buy opportunity for the aggressive contrarian as I discussed in chapter 11 of my book. But since he already has an above-normal long position I think he should just stick with it. The only event that could alter the situation would be an S&P 500 close at least 5% below its 200 day moving average. Such a close would suggest that the market has begun a new bear market. I don't think we will see such a close any time soon.

Bubbles, bubbles everywhere

Here is an image of the cover of the latest issue of The Economist magazine. The bull market in world stock markets is only 10 months old. For the most part world markets are trading visibly below their 2007 tops. The Economist admits that it sees no bubbles at the moment. But it asserts that assets are overvalued world-wide. It also predicts that unless monetary policy around the world gets tighter, bubbles will begin to inflate everywhere.

Here is my view. Assets now may well look overvalued. But markets are forward looking and are anticipating a strong economic recovery. At bull market tops one typically does not find much concern about overvalued assets or bubbles. So I think this cover is one more manifestation of the Wall of Worry that world stock markets are climbing.

I think the bull market is stocks has much further to go and will last at least through the end of 2010.