Sunday, January 27, 2013
I' mmmmm baaack!
I want to point out one change to which we contrarians will have to adjust. The print media, the mainstay of my approach to identifying information cascades, are rapidly declining in significance relative to electronic sources of information. This is going to make it harder to identify information cascades, especially the bearish ones which typically come and go quickly. As a concrete instance of this trend one can point to the demise of Newsweek's print edition. Time magazine is evolving into a tabloid and so I think its usefullness is diminishing too.
A big part of the art of investing, and particularly of contrarian investing, is the ability to adjust to changing circumstances and market environments. So going forward I will be trying to incorporate more electronic sources of information as indicators of market sentiment to supplement my readings of newpaper headlines and magazine covers.
My last post on this blog was in December 2011. In it I said that pessimism about the US and European stock markets was thick and that this meant that higher prices were ahead. A few days after that post long term contrarian traders were confronted with a mechanical sell signal on December 20 in the S&P 500 when its 200 day moving average dropped 2% from its high point reached earlier in 2011 (chart is above this post). I personally ignored this signal as a matter of contrarian logic - if pessimism dominated the markets at the time then this sell signal would turn out to be wrong (and it was).
There were other technical reasons to doubt the signal. First, the Dow industrials never got even close to generating a similar sell signal. Secondly, when the S&P's 200 day moving average achieved its 2% decline on December 20 the S&P was actually above its rising 50 day moving average (wavy green line on the chart above). At the very least this would have been reason to delay acting on the mechanical sell signal. The next time the S&P traded below its 50 day moving average was in mid-2012 after the 200 day moving average had resumed its strong up trend.
Aggressive contrarians had abandoned long positions in late August 2011 near 1200 in the S&P. Needless to say I repurchased my own aggressive contrarian long position on the one day dip right after Christmas of 2011 at about the 1255 level. It has remained undisturbed since then.
At the top of this post is an image of the January 26 front page of the New York Times. For the first time in a very long while there is a headline about bullish stock market performance pointing out that the S&P has closed above the 1500 level for the first time in five years.
Is this a sign of a bullish information cascade? I am doubtful about this possibility. I think the man on the street is still pretty much out of the stock market and pessimistic about the US economy.
Nonetheless, one must recognize that S&P average has been moving generally upward for 46 months, an unusually long time for a market advance. And the average is approaching the levels of two big tops at 1553 in 2000 and 1576 in 2007. There was a lot of pessimism around at the time of the 2007 top. This fooled me then into thinking that the worst that was likely on the downside then would be a 20% or so drop.But things got a lot worse than I imagined they could. I don't plan to make this same mistake again. This is another reason for contrarians to take the headline above this post as an early warning of a possible storm ahead.
I think that both conservative and aggressive contrarians should now be looking for reasons to reduce the size of their long positions. Personally I think the advance from the November 2012 low point has further to go. I am looking for a move up to 1546 in the S&P. Once the market gets there, or if other bearish signs develop in the interim, I think it will be appropriate for aggressive contrarians to cut way back on their long postitions.
Conservative contrarians dodged a bullet in December 2011 when the S&P generated a mechanical sell signal which I ignored. I think it will be appropriate to take advantage of this fortunate circumstance to sell long positions at the same time that aggressive contrarians do even though this would violate the mechanical guidelines for conservative contrarians whichI set down in my book.
I will keep you posted on my thinking about these possibilities going forward.