Tuesday, August 9, 2011

Panic II

This morning's editions of The New York Times and the Chicago Tribune presented the front pages you see above this post. Just as it did this past Friday the stock market has made it into the headlines. Generally speaking big rallies start a day or two after headlines like these appear in the newspapers. Today's 6% rally from yesterday's close is probably only the first stage of a bigger move which should take the S&P (daily chart above this post) back above the 1200 level.

Aggressive contrarians still have above average long positions which were increased from average levels while the S&P was in the 1250-1290 range. This latest break has dropped the average nearly 20% from its May 2 high on an intraday basis. Frankly, this is a much bigger drop than normally appears in the context of an ongoing bull market.

For this reason I think it makes sense to adopt a defensive strategy even though the 200 day moving average of the S&P 500 (red line in the chart) has yet to turn downward by 2%, the mechanical method I prefer for signalling a bear market. I think the thing to do now is to hold on to long positions for the time being, but to adopt the strategy of dealing with bear market rallies which was described on page 133 of my book. Wait for the S&P 500 to close 1% above its 50 day moving average (the black wavy line on the chart) which currently is at 1293 but falling rapidly. When this happens reduce stock market exposure to below normal levels.

The blue arrow projects this drop in the moving average linearly into the future. It looks like the market is likely to meet its 50 day moving average somewhere in the 1200-30 range.

My best guess is that the drop from the May high at 1370 is only the first wave down in a bigger decline. I estimate that the low of this decline will develop somewhere in the 950-1000 range.

Conservative contrarians are still carrying a normal stock market long position. I think this is the appropriate strategy until such time as the 200 day moving average drops 2% from its recent high.


  1. Dear Carl,
    I am sure, as day changes with night that now you are on a better , more correct path, of reasoning. I (almost totally) agree with what you said above, even though, it is obvious, that we use very different methodologies to get to that conclusion.

    Everybody here remembers me calling this market BOOL MARKET and practically 50% (since APril 2010) drop of DOW in terms of Swissy, was a clear indication to me that, something was wrong with this "bulls market" idea.

    Nevertheless, I am glad we are on the same wave now
    Good Trading all.

  2. Doug Kass called a bottom today http://www.cnbc.com/id/44078875

    Selling in this market became so pronounced over the past 2 week that even some of the Street’s most celebrated bears think the next big move is higher!

    And Doug Kass is among them.

    Kass, the president of Seabreeze and CNBC Contributor who’s famous for his market timing tells us the stock market put in its 2011 low on Monday. And unlike other market watchers who say the same, Kass also says, "I do not think we're going to re-test the lows."

    S&P 500 Index
    1172.53 53.07 (+4.74%%)

    (We know some of you may be skeptical, but for what it's worth, last year -- on July 6, 2010, Kass said the market had made its lows for the year and his call proved to be extremely accurate.)

    Kass points to a slew of reasons that suggest the next big move is to the upside. They follow:

    1. The decline was so rapid and sharp that when he examines history and looks at similar moves “the mean return after 6 months is a gain of more than 10% and greater than 20% a year later,” he says.

    2. The market was so oversold, it suggests an abundance of fear is in the market, which in turn is bullish. “We’re now as oversold as we were when Germany invaded France in 1940 and after the 1987 crash.” Adding to that thesis, Reuters says The S&P 500 is now more technically oversold than at any other time in the last 10 years, with its 14-day relative strength index at 16.5 percent. A level below 20 generally attracts buyers.

    3. We’ve had an aha moment. Kass thinks the historic implication of the S&P downgrade will ultimately be a kind of wake-up call for lawmakers. “Now, I think we see renewed leadership” after an event that had been unthinkable became reality.

    4. Kass also points to the ratio between normalized earnings and corporate bond yields, which he says has never been more stretched. “That was my most important tell back in 2009,” he says. (Less than a week before the S&P 500 hit a generational low of 676 on March 9, 2009, Kass went on CNBC and predicted the bottom.

    5. And finally, he thinks fundamentals line up well for a rally. “The economy is growing,” he reminds, “although it’s growing more slowly than we’d like.”

    All told, Kass says these indicators, which are his most important 'tells' for market timing, are trending in a positive direction.

    And he’s putting his money where his mouth is. Kass also tells us that over the last 2 days he’s traded into net long positions. In fact, he’s the longest he’s been at anytime over the preceding 12 months.

  3. If 70% of trades are done by black box operations, do headlines even matter anymore? The machines have their instructions and they are out to make their daily rebates.

  4. So Carl what happened to the strong move to 1400. How can you say everyone is bearish when Investors Intelligence and AAII surveys show a high level of bullishness after a 2000pt drop in the Dow. Or for example large broker dealers like Goldman Sachs, Citi, etc were originally calling for the S&P500 to end at 1450-1500 by the end of 2011. Most of these calls were made at the start of the year and have been revised to 1400ish - so not really bearish. Newspapers generally sensationalize news. The man in the street enjoys stories about Wall Street suffering, especially given the fact that he is faced rising unemployment, declining wages, disunited politicians, to name a few issues, whilst Wall Street has had couple of bumper years (2009, 2010) - I know I work in Wall Street. Also, the down volume in this latest move since July has dwarfed the up volume, especially in the latter part of the up move.