The Art of Contrarian Trading

what hasn't happened

2011-12-09T13:10:00.003-05:00

There seems to be an emerging consensus that yesterday's EU summit meeting was a partial failure and a partial success - sort of like all the other EU initiatives taken to control a potential banking crisis.

There is an extraordinary conviction among investors and the this half -success, half-failure result was too little and too late, that an Euro zone break up is inevitable and will have devastating, world-wide economic consequences. At least that is what I am reading in the print media and getting from on-line sources.

Here are a few headlines I found within minutes of searching on line for reactions to the summit. They are quite representative.

"Europe's blithering idiots and their flim-flam treaty" - Ambrose Evans-Pritchard, The Telegraph (UK)

"Europe's Disastrous Summit" - Felix Salmon, Reuters US

"Eurozone banking system on verge of collapse" - Harry Wison, The Telegraph (UK)

I think I am on safe ground in asserting that a very bearish investment crowd has developed around this theme during the past few months.

The odd thing is that the European stock markets as well as the US market have rallied today - not by a huge amount - but quite substantially. I also note that the Euro-currency has been trading quietly for the past two weeks in a narrow range a little above its early October lows.

This surprises me, and I think it means that the widely accepted view that a European crash is imminent is wide of the mark. I think the Euro will rally against the dollar from here and that European and US stock prices will advance well above their late October highs.

important update

2011-08-31T13:50:00.005-04:00

In my last post I suggested that aggressive contrarians should wait until the cash S&P 500 closed above its 50 day moving average (red dash arrow) before reducing the current, above-average exposure to stock to below-average levels.

I had envisioned this happening around the 1220 level in the S&P. The market is currently trading there but the 50 day moving average is 30 points above the market. I think it is better to be safe than sorry, so I think aggressive contrarians should take advantage of current prices to reduce their stock market exposure to below-normal levels.

Panic II

2011-08-09T19:31:00.007-04:00

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.

Panic

2011-08-05T09:24:00.006-04:00

Here is the media reaction to the latest 12% drop in stocks which I think culminated in high volume, panic selling yesterday.

My favorite image is right above this post and appeared on page one of today's Chicago Tribune business section. In big, black, block letters, the Tribune's business editor leaves no doubt about what he or she thinks you should do!

Above that are images of today's front pages of the Tribune and of the New York Times. The stock market is in the headlines, spread across the front page, in both papers. The emotional content of the headlines is subdued relative to those we saw in 2008-09 but I wouldn't expect to find hysteria in the headlines in a bull market.

The top chart is a daily bar chart of the cash S&P 500 going back to the start of 2010. The most significant thing about this chart is that the 200 day moving average is still rising. Unless and until it drops 2% or more the bull market is entitled to the benefit of the doubt. In a bull market a drop below the moving average is a buying opportunity. Compare this one with the one we saw in 2010 (green dash ovals).

I think this is a buying opportunity for the contrarian investor. The aggressive contrarian strategy I described in my book already has an above average commitment to stocks so no action is called for.

I think that this selling squall will soon pass and that the S&P will resume its bull market advance to new highs above the May top at 1370.

euro trash

2011-07-19T09:10:00.005-04:00

The image immediately above this post is the cover of Der Spiegel (the Time magazine of Germany) which appeared during the last week of June. The cover image is of a casket draped with the Greek flag on which a picture of the one euro coin appears. The caption reads "Sudden and Expected - Obituary for a Common Currency".

Above that cover image is the cover of the latest Economist in the colors of fear and danger - red and black. It shows the one euro coin teetering on the edge of a precipice which takes the shape of Italy, the latest worry of Euro bond traders.

Normally I don't pay much attention to covers like these unless the market in question is at an obvious extreme in price. The Euro currency is not, at least not against the dollar.

Even so, I think it is remarkable how universal is the bearish sentiment about the Euro which is expressed by these two cover images. I happen to think the Euro is headed for 1.5000 against the dollar. These covers make me think that it has a good shot at its all time high of 1.6039 against the dollar. I think Europe will muddle through the current crisis. Global economic activity in the US and Europe will begin to pick up and this will ease the pressure on European banks, increase tax revenue, and temporarily put off default by Greece.

Update

2011-06-16T13:17:00.002-04:00

Here is an image of today's front page of The New York Times. The stock market hasn't made it into the headlines yet, but the story is at the top of page 1 right next to the headline. I think this just reinforces the conclusion I reached in this last post.

BUY say the New York Times and Time Magazine

2011-06-13T09:27:00.006-04:00

Wow! The cover of the latest issue of Time Magazine is above this post. Black headlines bordered by red - the colors of danger and fear. The five myths cited on the cover are in my view not myths at all - but they are what Time thinks its readers believe and it is happy to reinforce those fears. The torn dollar whose pieces shrink in size moving from left to right (the direction of time progression) symbolize the shrinking values of stocks, real estate, and the US dollar, and the shrinking purchasing power of the dollar in times of high food and oil prices.

The New York Times chimed in Saturday with a stock market story on page 1, above the fold and just to the left of the headline column. "Stocks Plunge" is a pretty emotional description of what happened Friday and of the trend since May 2.

Take a look at the daily bar chart of the S&P 500 which goes back to the start of the bull market in March 2009. Notice the the S&P is above its rising 200 day moving average (red line), a fact that warrants the presumption that the bull market is still intact. Note too that the drop from the May 2 top is comparable to several other reactions seen within this bull market. In fact the market is still above the steep trend line (green dash line) I have drawn through the March 2009 and July 2010 lows. It is also above the April 2010 top.

Finally note that while the S&P is above its rising 200 day moving average it is well below its 50 day moving average (wiggly blue line), a typical buy configuration in a bull market.

Taken together these facts all point to a market which is offering aggressive contrarians a terrific buying opportunity. I think the S&P will be much higher 6 months from now and will probably reach the 1500 level before this bull market ends.

the rear view mirror

2011-06-09T13:42:00.005-04:00

As the saying goes, gloom among investors and the public is now so thick you can cut it with a knife.

The chart right above this post shows the 30 year record of people's expectations that their income will increase during the coming year. For the past two years this percentage has been hovering at its lowest levels of the past 30 years. During this time of pessimism the stock market has steadily advanced.

Of more immediate interest is the middle chart. It shows the results of the weekly survey of investor sentiment conducted by the American Association of Individual Investors. The blue line is the weekly ratio of the number of bears divided by the number of bulls plus the number of bears. The higher the number the more bearish is the average investor. The five week moving average of this poll is depicted by the red line.

On a moving average basis AAII investor sentiment is the most bearish it has been during the past 18 months, and is even more bearish that at last year's July low which ended a 17% drop. This is remarkable because the S&P 500 has dropped barely 9% from its May high.

In fact the latest drop looks perfectly normal in the context of corrections within this bull market (blue dash rectangles in top chart). The 200 day moving average (red line in top chart) is rising strongly and the market is well above it. The S&P is also well below its 50 day moving average.

This combination of circumstances is an buying opportunity for the aggressive contrarian. In my view the aggressive contrarian would have assumed an above average long position near the April 2011 lows after dropping to only a normal long position last November. So while no new buying is possible I think this above average long position should be held. The S&P should soon move to new highs for the bull market.

the beat (of pessimism) goes on....and on...and......

2011-05-03T11:51:00.004-04:00

Here is an image of the cover of the latest Economist. I love the line chart of a "crash" photoshopped onto Miss Liberty's tablet.

The Economist is a little late to the pessimists' party, but does contribute its bit to the chorus of naysaying. As I have repeatedly emphasized here, the pessimists are going to have to quiet down quite a bit before this bull market ends in the US, and indeed in the rest of the world too.

Gloom

2011-04-25T13:09:00.005-04:00

Here are images of the front page from The New York Times for this past Friday, Saturday, and Sunday. Friday's headline included the phrases "...Darkening Mood..." and "...Pessimism On Economy...". Saturday's headline informed us that "Bad Times Linger...". On Sunday at the top left of page 1 was a story headlined "Stimulus By Fed Is Disappointing..."

I think the New York Times is accurately reflecting (and reinforcing) the public mood at the present time. This is good evidence that no bullish investment crowd of any consequence has built up in the US stock market. Until the public gloom lifts substantially stock prices will only go higher.

opportunity for the aggressive contrarian

2011-04-19T12:04:00.004-04:00

At the top of this post you will see an image of today's front page of The New York Times. This is the first time in quite a while that the stock market was mentioned in the headline. It is a very subdued mention. But it comes a month after the "Apocalypse Now" cover in Newsweek. And the S&P 500 is below its 50 day moving average (blue wavy line on the chart) and above a rising 200 day moving average (red wavy line).

The credit warning by S&P for the USA is complete nonsense. The US governments debt is denominated in dollars which the Federal reserve can print at will. There is no chance whatsoever that the US will default on its dollar denominated debt. Yet on the news yesterday the S&P 500 dropped nearly 2% within an hour of the announcement. Dumb selling if ever there is such a thing.

I think the aggressive contrarian should move to an above average long position from just an average one. Before anything resembling a bear market develops in the US stock market I think we shall see the S&P at 1500 and the Dow at 14000.

Apocalypse Now !!

2011-03-23T11:20:00.004-04:00

Here is the cover of the latest edition of Newsweek magazine. I think it is a good reflection of the over-the-top reaction to the disaster in Japan. Irrational fears of radiation overdoses make people crazy. (Geiger counters for radiation detection have sold out of the stores in Paris!)

At the top of this post is a weekly chart of the Tokyo Nikkei stock market average. You can see the panic drop on the earthquake- tsunami - nuclear meltdown fears. The Japanese market has since recovered part of that drop. I think it is a buy at current levels.

The Newsweek cover is not something I would expect to see near a bull market top. I think that the current bull market has further to go - at least to the S&P 1400 level and probably to 1500 or so. This would put the Dow at new historical highs near 15,000.

America in Decline ... (NOT!!)

2011-03-09T09:12:00.003-05:00

Here is the cover of the latest issue of Time Magazine. It does not directly comment on any market. But despite the ham-handed attempt at editorial balance, the cover makes it pretty clear what the Times editors and, by inference, their readers believe.

This is not the kind of cover story one sees anywhere near a bull market top. It just reinforces my belief that stock prices in the USA have much further to rise before a drop of as much as 25% can materialize.

crude oil redux

2011-03-08T09:13:00.004-05:00

Two weeks ago I highlighted the New York times headline on crude oil prices. Crude prices have moved up about five dollars a barrel since then. Above this post you will find two more pieces of evidence for what I see as a bullish investment crowd in crude oil.

The first image is of the latest cover of The Economist. It tells us that crude oil prices have lit the fuse of a bomb which will destroy the worldwide economic recovery.

The second image is of the front page of today's Chicago Tribune. It speaks for itself.

At the top of this post is a monthly chart of West Texas crude oil prices. The market is still trading well shy of its 2008 high of $147. But it is also up 300% from the $35 low of late 2008 and has been moving steadily higher for more than two years.

I think that while prices will probably move higher from here, maybe to $112 or so, the next big swing in crude oil prices will be downward.

crude oil

2011-02-23T09:02:00.004-05:00

Things have been pretty quiet on newspaper front pages and on magazine covers over the past few months. But this morning the New York Times headline concerned the oil market (image at top of this post).

The headline itself is emotionally very restrained. However, I do think that the two year rally from the December 2008 low at $35 has built up a substantial bullish investment crowd in the oil market. People keep telling me that oil can only go up from here because of inflation, and improving world economy, etc.

But oil is a commodity like other commodities, and it has a substitute for many bulk uses - natural gas. Natural gas prices are near historically low levels and I think this is not only going to keep a lid on oil prices but will also soon be exerting substantial downward pressure on the crude market.

Political uncertainties may well drive crude a little higher, say into the 100-105 range. But once the psychological $100 barrier is breached I think sellers will come out in droves. Within a couple of years crude oil should be selling below $50.

QE2

2011-01-22T10:43:00.002-05:00

I have been reading a lot of nonsense about the effects of the Fed's policy of quantitative easing (QE2). Here is my e-mail response to a friend who asked me about this:

Catherine:

I think Bernanke did exactly the right thing when he pushed the Fed into QE2. Moreover, at least so far, QE2 is a success. How do I know? First, the dollar index is going down (and I think it has a good shot at 65 - but when QE stops the dollar will rally, and rally big time). Second, the yield on the US 10 year is going up while the tips spreads are pretty much unchanged. This shows the bond market is expecting more economic growth, not more inflation. Third, the US stock market is going up, also reflecting expectations of higher growth.

QE works by inflating asset prices (stocks, commodities, real estate and other real assets) which rise initially because investors re-balance their portfolios after they sell assets to the Fed. But rising asset prices encourage their production (real investment) and also make people more optimistic about the future (more bullish "animal spirits" to borrow Keynes' phrase). These last two effects boost economic growth if there is slack in the economy as there is now.

Carl

back to normal long positions

2010-11-09T10:01:00.005-05:00

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

2010-11-04T11:16:00.005-04:00

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

2010-10-27T18:08:00.006-04:00

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

2010-08-30T11:41:00.005-04:00

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

2010-08-23T10:42:00.004-04:00

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

2010-08-09T08:53:00.003-04:00

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

2010-07-26T08:47:00.006-04:00

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

2010-07-19T08:49:00.004-04:00

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

2010-07-12T09:08:00.002-04:00

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

2010-07-06T09:22:00.005-04:00

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

2010-06-11T11:43:00.003-04:00

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?

2010-06-01T11:05:00.003-04:00

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

2010-05-27T10:22:00.003-04:00

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

2010-05-11T12:30:00.007-04:00

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...

2010-05-10T09:53:00.005-04:00

... 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

2010-05-07T08:46:00.005-04:00

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

2010-05-03T11:57:00.002-04:00

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

2010-04-20T19:02:00.020-04:00

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."

********************************************

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!

2010-04-14T12:38:00.005-04:00

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

2010-04-05T11:51:00.007-04:00

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

2010-03-31T13:21:00.005-04:00

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

2010-03-08T09:12:00.008-05:00

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

2010-02-16T11:22:00.003-05:00

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

2010-02-08T11:14:00.004-05:00

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

2010-01-11T13:38:00.003-05:00

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.

So What?

2009-12-31T14:08:00.005-05:00

Here is a chart of the Investor's Intelligence Advisor's survey that comes to us courtesty of Elliott Wave International. I want to use this chart to illustrate the futility of drawing anything other than relatively short term conclusions from sentiment data polls.

A large number of blogs and opinion makers I follow cite the current high level of bullish sentiment among newsletter writers as evidence that another bear market leg is about to start. Some even think it will drop the averages below their March 2009 lows.

I remember a similar situation back in June of 2003, about 8 months after the October 2002 bear market low (first vertical green arrow on the chart). At the time bullish sentiment was even higher than it is now (blue dotted line). But the market advanced an additional 50% during the subsequent four years, a bull market punctuated by reactions of less than 10% in the averages during that time.

So what can we conclude about the future course of the averages from the current level of bullish sentiment among investment newsletters? Not a thing! At worst it suggests that a reaction of perhaps 10% or so is likely to develop within the next few weeks. But even that is not a forecast that can be written in stone.

What matters most for the market's longer term direction is that the general public still hates stocks and is pessimistic about the economy. Until that gloom lifts this bull market will continue.

Big Ben

2009-12-18T11:26:00.004-05:00

Ben Bernanke, the chairman of the U.S. Federal Reserve, is Time magazine's 2009 person of the year. I have been thinking about the significance of this cover. Here are my conclusions.

First, I think that this marks the high point of the public awareness of Bernanke's economic role in the U.S. and world economy. If I'm right about this there will be no more financial or economic crises that require the Fed's emergency intervention for the foreseeable future, i.e. for the next several years. This means that the March 2009 low is in all likelihood a once-in-a-generation low point for stock prices.

It also means that interest rates are about to return to more normal levels, levels which reflect expectations for average economic growth and growing employment in the U.S. and the world. In particular, the gap between short term rates and the 10 year note yield should start to shrink significantly and the yield curve should start to flatten a great deal.

Finally, since interest rates are likely to rise in the U.S. and since the Fed is likely to scale back its support for the securities markets, I think the U.S. dollar is likely to begin a long and extended bull market, one which will carry the dollar index to the 100 level. In this connection I would bring your attention to the background for the cover image of Bernanke you see above. It is an image of the U.S one dollar bill with Bernanke's picture in place of George Washington's.

Sell your villa on the Riviera and buy one in Palm Springs!

A few more bricks for the Wall Of Worry

2009-12-01T12:49:00.007-05:00

Here are three recent items from the news media that show the Wall Of Worry on Wall Street is still getting higher. The top image is the latest cover of Newsweek. The story is by Niall Ferguson, a very talented historian, author, and financial journalist. Over the past year he has also found a big audience among doom and gloomers. The thrust of his Newsweek story is that the U.S. budget deficits, current and projected, and the resulting projected increase in the Federal debt are unsustainable. He offers no solutions, but does assert that the U.S. in well along the road to disaster. Why similar disasters won't afflict the rest of the world he doesn't say.

The middle item is a chart from Floyd Norris' New York Times column this past Saturday. It is a chart of one of the major surveys of consumer confidence. You can see that it has reached the lowest level seen during the past 30 years.

Right above this post is the front page of the Chicago Tribune's business section of November 25. The headline speaks for itself.

As you know I think the U.S. stock market is in the middle of a bull market which I expect will last through the end of 2010. By that time I expect to the the S&P 500 close to its 2007 high of 1576. The articles and images above reinforce my view that public sentiment is still quite bearish, despite a 60% advance in the market averages during the past 9 months. While a drop of 5-10% in the S&P can occur at any time, I think it would present another buying opportunity for the contrarian investor.

A review of my book

2009-11-13T12:23:00.002-05:00

Here is a very kind review of my book by someone I don't know and have never met. You can check out the rest of the Amazon reviews by clicking on this link.

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1 of 1 people found the following review helpful:

A Grateful Reader, November 12, 2009

By	Trading Truth Seeker "K" (Wesley Chapel, FL) - See all my reviews

Back in 1990 I read an article in the July/Aug issue of the Commodity Traders Consumer Report(CTCR)that forever turned my trading mindset around. Carl Futia wrote the article. And no, I don't personally know Mr. Futia, and I have no interests financial or otherwise in his world. But in my 25 years of trading, I can honestly say that this article helped to shape my trading mindset forever. To make a long story short, I'll quote and explain to you the two concepts from that 1990 article that engendered the changes in my trading mind.

Concept #1: Quote: "I had seen clearly that if I relied on oscillators and trend-following techniques, I was always getting into the trend too late. It struck me that I should try to "Anticipate" the beginning of trends rather than waiting to enter in the middle after they had started".

Concept #2: This concept was the idea of "Free Exposure" which Mr. Futia was taught from a seminar by the legendary trader Peter J. Steidlmayer. In essence Free Exposure meant; To enter the market where the risk is the least and the reward is the greatest, one must find, and be able to read where "Value" lies in the market. All entries made at "Value" are essentially tantamount to a "Free" ride in the market, with very little risk "Exposure".

These two concepts started me on my mental journey into what I now call "Anticipating Value" in the market. In any case, back then, after doing months of research and extensive reading on these two concepts my trading was completely turned around for the better. Today, both concepts have melded in one technique, and now form the foundational element of my trading strategy and methodology. Further, since reading this new book, I can see that most of his ideas have since matured into a cohesive philosophy, worthy of anyone's personal library. And by the way, my personal library once numbered over 800 books, so I believe I know a good one when I see it.

Thankfully, I too arrived at some of those same conclusions in his book a long time ago. This is because they were the natural and logical progression from his initial concepts in the 90's. Do yourself a favor and at least read this book, even though you may not agree with it now. Some time in the future, after you have been "sorely tested" in the market for a while, you may be truly thankful that you did. It might just spark a new way of looking at the market for you.

More bearish than at 866

2009-11-09T10:28:00.003-05:00

Here is a chart showing the weekly sentiment survey conducted by the American Association of Individual Investors (chart courtesy of DecisionPoint.com). The red bars represent the percentage of responses that were bearish, the green bars represent the bullish percentage, while the purple bars at the bottom express the ratio of bulls to bears.

Notice that the bearish percentage is currently higher than it was at the July low of 866 while the bull/bear ratio is lower than it was then. This is one piece of evidence that makes me think the November 2 low is comparable in importance to the July 8 low. If I am right about this then the market has probably started a rally that will carry well past the 1120 level I have been mentioning. How far past 1120? The most optimistic projection would be to the 1240 level. This would put the next top as far above the 1099 top as the 1099 top was above the June 2009 top of 957. Cutting that 140 point difference in half still projects to 1170.

Main Street Hates Wall Street

2009-11-09T10:15:00.006-05:00

At the top of this post is an image of the cover of the current issue of Time Magazine. The sentiment it conveys should be no surprise. But ask yourself: is it likely that stock prices will begin a new bear market and drop substantially from current levels when the public hates Wall Street and the stock market so much?

The Newseek cover you see above is from the March 30, 2009 issue. On that date the S&P was trading near 780 versus its current level of 1080. While I don't expect another 300 point rally from here over the next six months, I do think that the still bearish condition of investor sentiment is telling us that the trend during that time, and through all of 2010, will be upward.

Gloom and Boom

2009-11-05T10:59:00.004-05:00

Here are a pair of images (top one from the Chicago Tribune and the bottom one from inside the latest issue of Newsweek) which I think captures well the public's mood about the economy and the stock market. The images speak for themselves. This is not a psychological environment in which any significant (say more than 10%) drop in stock prices is likely, or even possible.

The Goracle

2009-11-05T10:54:00.004-05:00

Here is an image of the cover of Newsweek's latest issue. It depicts the Goracle, Al Gore, who aims to be the first "green" billionaire.

From this and from related considerations I draw these conclusions:

The planet is currently cooling, not warming
Kyoto is dead and there will be no agreement on a similar climate treaty which even pretends to bind developed nations to carbon limits
Cap and Trade? - dead
Buy carbon !

A new bullmarket in NYX - the New York Stock Exchange

2009-10-15T14:46:00.004-04:00

Here is an image of the front page of today's New York Times. At the top left you will find a story about the New York Stock Exchange. It tells us that the exchange has fallen on hard times because of new competition from electronic markets and it generally paints a bleak picture of the NYSE's future.

At the top of this post you will see a weekly chart of NYX, the common stock of the NYSE-Euronext, the parent company of the exchange. The panic of 2008 was not kind to NYX - the stock had lost more than 80% of its value at its low point in March of 2009.

Here we have a classic contrarian combination. A devastating drop in a stock coupled with a bearish front page story about the company in the New York Times. Icing on the contrarian cake is the fact that the 200 day moving average of NYX (red line on the chart) has turned decisively upward in the face of a lot of bad earnings news.

I think NYX will move much higher during the next fifteen months. A reasonable expectation is midpoint resistance that stands near 74 (purple dotted line).

Dollar is scraping bottom

2009-10-14T12:18:00.003-04:00

Here is an image of the front page of today's Chicago Tribune business section. I think it shows that bearish sentiment about the U.S. dollar is pretty extreme. I think that the 75 level in the dollar index will prove to be strong support. The next big move in the dollar will be upward from here and should carry the dollar index to 100 or higher.

Shanghai Update

2009-10-12T14:00:00.002-04:00

Here is an updated daily chart of the Shanghai Stock Exchange composite index. I last commented on this market here.

As you can see the drop from the from the early August high ended in early September, just about in the target area I had highlighted (purple oval). That target represented the confluence of the rising blue trend line and midpoint support denoted by the horizontal red dash line.

I think a move to new bull market highs for this index is about to start. It should carry the index above the 4000 level before another substantial break begins.

Climbing the Wall of Worry

2009-10-12T09:53:00.003-04:00

Here is an image of the cover of Time Magazine's latest issue. I don't think it has any immediate implications for the stock market's trend over the next few weeks. But I think it does accurately reflect (and reinforce) the public's current attitude towards stock market investing. The stock market turns people off - largely because of its very negative performance during the panic of 2008.

This cover story reinforces my conviction that the "wall of worry" that the stock market climbs during a bull market is a solid one and extends much further upward from here. We won't see covers like this one near the top of the current bull market. This top is not likely to develop until late 2010 and I think it will return the Dow and the S&P 500 to within whispering distance of their 2007 high points.

Confirmed Bull Market !

2009-09-01T14:17:00.004-04:00

As you can see in this chart, the 200 day moving average of the S&P 500 index has risen 1% above the lowest level it reached during the 2007-09 bear market. In my book on pages 129-130 I explained the contrarian rebalancing strategy for stock market investment, a method that I think is well suited for the conservative contrarian trader. This advance of 1% in the S&P's 200 day moving average has special significance for the conservative contrarian who is following this strategy. Since a huge bear market crowd had developed during the bear market the rally in the 200 day moving average means that the conservative contrarian should now adopt an aggressively bullish stance toward the U.S. stock market. He does this by moving money from bonds and cash into stock market index funds or ETF's until he has an above-normal portion of his portfolio invested in the stock market.

When will the conservative contrarian move back to just a normal stock market position instead of an agressively bullish one? In my book I said that the wisest course is to wait for the bull market to develop until prices have risen for at least 20 months after the start of the bull market and have risen at least 65% from the preceding bear market low. So the conservative contrarian would now be expecting to stick with his above-normal long position until November of 2010 and until the S&P has risen as least as far as 1100.

Hollywood Horror

2009-08-24T10:16:00.002-04:00

In my book I emphasize that a contarian trader has to be on the look out for signs of crowd sentiment and group think that show up in unusual ways - not simply in newspaper headlines or magazine covers.

Yesterday I went to see Quentin Tarrantino's new film Inglourious Basterds. What struck me from a contrarian standpoint was not his film but the movie trailers (advertising upcoming movie releases) that preceded it.

The trailers started with one promoting Jay Leno's new prime time show. It placed Leno in some sort of cave and in a situation where he was being threatened by mysterious and malevolent forces. It ended with Leno running while looking into the camera and saying "If I get out of this alive watch me on prime time this fall!". Quite an interesting way to promote a comedy hour!

Then there followed six (count 'em, six!) trailers for what can only be described as horror films, including Halloween II and Wolfman. Every single trailer conveyed dark, terrifying moods and showed scenes in which monsters of one sort or another were attacking ordinary people.

Keep in mind that these films are in production this year and so were in the idea and contract stage in 2007 and 2008. I take this as yet another manifestion of the public's dark mood in 2008. Hollywood is a media business and as such tries to give people what they want to watch. Evidently its media moguls figured that horror films fitted well with the public's mood in 2007 and especially 2008.

This is just one more indication of the strength of the bearish stock market crowd that I think reached its maximum in March of this year. The intensity of the emotions (principally fear) of this crowd probably set some sort of record, and I think the movie trailers I saw are good evidence for this.

The main thing to keep in mind is that emotional swings in crowds take a long time to play out. The bearish sentiment of the stock market crowd at the March lows was so extreme that I think it will take years to dissapate. This to me means that the March 2009 low was probably a generational low, similar to 1932 and 1974.

On the Gabe Wisdom Show

2009-08-20T08:52:00.001-04:00

Yesterday the talk radio host Gabe Wisdom taped an interview with me about my book. You can listen to it here or you can go to this page to listen to or download the entire 60 minute show (click on the August 19 show). I am talking during minutes 8-18, 22-27, and 32-38.

China Bubble Revisited

2009-08-19T12:27:00.008-04:00

The Chinese stock market has had a big break of nearly 20% over the past two weeks. A daily bar chart of the last year's action of the Shanghai composite index is at the top of this post.

Below that chart you will see an image of the cover of the latest issue of The Economist. I've noticed that some commentators are offering this cover story as a contrarian justification for thinking that the rise in the Chinese stock averages over the past 9 months is a bubble - with the implication that a crash is underway.

I commented on this situation a couple of weeks ago in this post. There I observed that bubbles can develop when markets are at all time highs, but are very, very unlikely when the market is nearly 50% below its all time high as the Shanghai composite index was a few weeks ago at 3400. Of even more importance is the fact that after a 75% drop in prices a huge bear market crowd always forms - China is no exception to this rule. And it takes years, not months, for the bear crowd to disintegrate.

So I don't think we have seen a stock market bubble in China end at the 3400 level in early August. Instead I think the Shanghai composite is in a bull market that will probably take it above the 5000 level over the next couple of years. Notice that the 200 day moving average (red line highlighted by green arrow) is trending upward with the current price well above that line. This is a positive evidence for an ongoing bull market. I expect the drop from the August highs near 3400 to end not far from current levels.

How far down is the drop from the 3400 level likely to carry? I have drawn a trend line (blue dash line) connecting the reaction lows of the bull market thus far. It currently stands at about 2650. The midpoint of the up swing that started in early March 2009 is roughly at 2775 (horizontal red dash line). So I think this reaction will end somewhere in the purple oval.

Another remark on contrarian thinking. After a bubble or a crash in any market the subsequent move in the opposite direction always attracts the attention of amateur contrarians. They offer headlines or cover stories like this one from The Economist as reasons why recent history is about to repeat itself. But in this they are generals fighting the last war because, in retrospect, it looked so easy to win. They ignore the dynamics of market crowds-it takes a long time for public sentiment to swing from bearish to bullish or from bullish to bearish.

In the case of the Chinese stock market lots of current bears want a chance to be heroes - in retrospect they see how they could have easily handled the 2007-08 bear market in the Shanghai composite if only they had seen it coming. They want to fight the last war because it looks easy in retrospect. I fear their hopes will be disappointed.

Conservative Contrarians - get ready to rumble

2009-08-03T13:31:00.003-04:00

In my book on pages 129-130 I suggested a simple market strategy for the conservative contrarian trader. After a bearish investment crowd like the one which developed during 2008 becomes prominent the conservative contrarian waits for an upturn of 1% in the 200 day moving average of the S&P 500. Once this happens he increases his stock market commitment to above normal levels.

I think this signal will develop sometime during the next six weeks. I think the 200 day moving average of the S&P hit its bear market low at 870.57 on July 27. Once this moving average rises to 879.28 or higher the conservative contrarian will get confirmation that a new bull market is underway. After taking an above normal long position in stocks the conservative contrarian then waits for the bull market to develop. A normal advance would take the S&P up at least 65% from its 666 low to the 1100 level or higher. A normal advance is also likely to last at least 20 months, i.e. until November of 2010. Once both these expectations are satisfied the conservative contrarian then expects to reduce his stock market exposure to normal levels.

Contrary Opinion Forum

2009-07-28T13:00:00.002-04:00

Each year at the Basin Harbor Club in beautiful Vergennes, Vermont the Contrary Opinion Forum meets. It is a three day gathering of contrarian minded investors and money managers. They share meals and hear distinguished contrarians offer their views on the state of the markets and new investment themes and techniques.

I have attended a few of these Forums and always returned home reenergized with new ideas and outlooks. Plus the Basin Harbor Club's setting amidst Vermont's beautiful wooded hills when fall colors are at their peak is worth the registration fee all by itself.

Take a look at this years schedule.

Is the recession over ?

2009-07-28T11:28:00.005-04:00

Is the recession over? I think the odds favor the view that if it isn't already over it will end within the next couple of months. Of course, unemployment generally continues to rise even after a recession ends. But the fact that the stock market made a low nearly 5 months ago is a strong indication that economic activity will grow stronger as the months pass. Historically speaking, a stock market low precedes the end of a recession by less than 6 months.

The first chart above this post comes from the July 25 edition of the New York Times. It appeared in Floyd Norris' column. It depicts the behavior of the index of leading indicators near the troughs of recessions which occurred during the past 40 years. You can see that the index of leading indicators is trending strongly higher now and that is almost a sure sign that economic activity is starting to pick up and that the recession's end is imminent.

At the top of this post is an image of the latest Newsweek magazine cover. It depicts a balloon labeled "The Recession is over" about to be pricked and deflated by a pin labeled "good luck surviving the recovery". The cover story inside the magazine follows that theme. It says that even if a recovery has begun, it will be slow and that the next few years will feel like a recession anyway. Moreover, it goes further by asserting that this economic recovery will be qualitatively and quantitatively different from past recoveries - the damage done by the collapse in confidence will supposedly limit the economy's ability to grow for years.

From a contrarian traders's point of view this cover is more evidence that the bull market signal for aggressive contrarians will work out well. Newsweek is feeding the predjudices of the enormous bear market investment crowd that developed during 2008. But as prices rise this crowd will start to disintegrate and the resulting buying will provide a very strong upward impetus to the market averages.

One more observation: it is a well-established empirical fact about recessions that fast, deep declines in economic activity are followed by fast, steep recoveries. So Newsweek's prediction that this time will be different flies in the face of historical precedent.

A China Bubble ?

2009-07-27T11:45:00.008-04:00

Every so often a new media theme catches my attention, usually because I see it mentioned in various publications and/or blogs within a fairly short period of time. Lately I have been reading about what some people claim is a "bubble" in the Chinese economy and/or its stock market. A weekly chart of this index is visible just above this post.

A couple of weeks ago an academic paper by some "econophysicists" appeared which asserted that a bubble in the Shanghai composite index had developed. At the top of this post you can see an image of the chart which appeared in that academic paper. The paper's authors concluded:

"By the very nature of the model, this result gives us two conclusions. Firstly, there exists a bubble in the Shanghai Composite Index. Secondly, it will reach a critical level around July 17-27, 2009. This will lead to a change in regime which may be a crash or a more gently bubble deflation. "

Is there really a China Bubble?

I don't think so and here is my reason.

It is always possible to recognize an incipient bubble by looking at the price chart of the asset in question. I discuss this point on pages 112-114 of my book. What should you see on the chart? Well, you should see a prolonged period of advancing prices, generally measured in years, which has brought the price of the asset to new historical highs. Do we see this the chart of the Shanghai composite index?

Definitely not. Prices have been rising for less than a year from a low point in 2008. And that low culminated a drop of nearly 75% in the index - a drop that doubtlessly produced an enormous bear crowd in the Chinese stock market. It takes a long time for extensive bearish sentiment to dissipate and be replaced by correspondingly strong bullish sentiment. Eight months is not nearly enough time - eight years is more like it. Moreover, as you can see on the chart, the index is trading at only about half the level of its 2007 high point. There won't be any possibility of a bubble until the index is at new historical highs above 6100.

So I think the prediction of the econophysicists will be proven wrong because they have ignored the nature of the mechanism which produces bubbles and subsequent crashes.

More bull market evidence

2009-07-23T12:31:00.007-04:00

It is often hard to adopt a bullish stance after an extended bear market ends. This is even more true after a year long panic like the Panic of 2008. The relentless barrage of bearish news and commentary in the media affects even the most dedicated contrarian.

Sometimes an antidote can be found by looking at charts which depict the market's behavior from different points of view. If you have read my book you know that I like to use the S&P 500 composite index as my principal market indicator. This index appears as the middle chart above this post. The 200 day moving average of the S&P 500 is still dropping sharply. The conservative contrarian is waiting for this moving average to turn upward by 1% before moving to an above-normal stock market allocation. It looks like this move is still some months away. But by looking at the market from other perspectives the conservative contrarian can prepare himself mentally to make the switch at the right time with confidence.

The chart immediately above this post shows the Nasdaq composite index. It is behaving more bullishly than the S&P. It has already moved well above its October 2008 high point while the S&P is still 70 points below its corresponding high. The Nasday is more than 20% above its 200 day moving average while the S&P is only 12% above its moving average. The Nasdaq moving average has actually leveled out and appears ready to turn upward - there is as yet no sign of similar behavior in the 200 day moving average of the S&P 500.

The top chart presents the most bullish picture of all. It is a chart of the cumulative total of the difference between the number of advancing and the number of declining issues each day on the New York Stock Exchange. The blue line on this chart is the 200 day moving average of this advance-decline line. It has already turned slightly upward. The advance-deline line itself has risen above its August 2008 high, a level corresponding to the 1315 level in the S&P 500.

I think these charts show that the tide has turned. A new bull market has started. It will probably last through the end of 2010 and carry the S&P closer to its 2007 high at 1576 than anyone now imagines. But I think it is generally a mistake to invest based on forecasts. With this in mind the conservative contrarian should continue to wait for an up turn of 1% in the 200 day moving average of the S&P 500 before moving more money into the stock market.

A word to the aggressive contrarian. You took an above-normal long position at the 685 level near the March low point of 666. Follow the plan outlined on pages 133-34 of my book. Wait for six months to elapse from the March 6, 2009 low (i.e. wailt until early September). Then start watching the 50 day moving average of the S&P 500 (blue line in the chart). Once you see the 50 day moving average drop by 1% from a high point for the swing up from the March low reduce your long postion back to normal levels.

New Bull Market

2009-07-17T10:29:00.005-04:00

Here is a daily chart of the S&P 500 covering the last year or so. Those of you who have read my book know that Wednesday was an important market event for the aggressive contrarian trader.

On pages 130-135 I described the market tactics I think an aggressive contrarian should follow. These tactics differ according to whether the aggressive contrarian believes the S&P 500 is in a bull market or a bear market. As I explained in my book, the simplest way to make this distinction is to compare the daily close in the S&P 500 to the 200 day moving average of these closes. A bull market is signaled when there is a close that is 5% higher that the 200 day moving average. This occurred for the first time in 18 months this past Wednesday when the S&P closed at 933 when its 200 day moving average was about 875.

At the moment, as I explained this this previous post, the aggressive contrarian already has an above-average long position. He did his buying in early March near the S&P 680 level. As I explained in that post and in my book the aggressive contrarian is waiting for September and for the first downturn in the 50 day moving average of the S&P that occurs after the first week of September from a new rally high. That will be his signal to reduce his long position from above normal to normal bull market levels.

How far might this bull market carry? As I explained in my book, historical precedent tells us that most bull markets last at least 20 months and carry the S&P 500 up at least 65% from its bear market low. Using this as a minimum expectation we would expect the S&P to advance to at least 1100 and reach its high in November 2010 or later.

The conservative contrarian is still waiting for an up turn in the 200 day moving average by at least 1% before he increases his long side exposure to stocks to above average levels.

That dog didnt' bark

2009-07-15T16:00:00.003-04:00

Here is an hourly chart of the e-mini day session for the past six weeks. The rally from Monday morning's early low has been almost uncorrected - a very unusual show of strength. In my judgment the Goldman Sachs and Intel earnings reports were not by themselves enough to push the market up like this in normal circumstances. But circumstances are not normal. There is a very large investment crowd that is betting that this market will go a lot lower because the economy is deteriorating. The earnings news has put a small hole in that particular balloon - the economy may in fact not be deteriorating. And so many are so under invested that it doesn't take much to scare them back into the market. I think there is much more portfolio reinvestment to come as bears gradually give up the ghost. This market is headed much higher.

A contrarian goes to Barnes and Noble

2009-07-13T11:07:00.006-04:00

I like to visit my local Barnes and Noble bookstore for a lot of reasons. One of the most important is the information I glean as a contrarian trader from the covers of the many magazines on display. The topics and titles of new books that appear on B&N's shelves is another good source of information. Even the number of shelves displaying business and investment books can reveal useful information about the strength of an investment crowd. I discussed this aspect of contrarian information gathering on pages 120-21 of my book.

I visited Barnes and Noble this past Saturday. Three magazine covers caught my eye. You can see images of them above this post.

The Harper's cover photoshops president Obama's head atop an image of Herber Hoover's body. The title of the story is "Barack Hoover Obama - the Best and Brightest Blow it again". The Forbes cover screams that congress is stealing the recovery. And at the top left of the same cover appears what will probably become known as the worst investment advice of the century: dump stocks, buy bonds.

The Business Week cover touches on a favorite theme of mine - retirement fears. The punchiness of the cover comes from the cover image: a graph of declining stock prices ending as the back of a beach chair. Note the use of the color red - the color of danger and fear.

These three covers tell me that the bearish investment crowd that developed during the Crash of 2008 has hardly diminished in size or intensity during the market rally since the March 2009 lows.

Light the torches, grab your pitchfork !!

2009-07-13T10:50:00.004-04:00

Goldman Sachs is making money again!

Here is an image of today's front page of the New York Times. Note the story about Goldman's rumored profitable second quarter of 2009. It appears right under the headline story on the far right.

The article begins:" Most of Wall Street, and America, is still waiting for an economic recovery. Then there is Goldman Sachs". The story drips with envy, suspicion, and contempt for Goldman, evidently because they are making money by taking risks others are unwilling, unable, or fearful of bearing.

This is just one manifestation of the "lynch mob" mentality so prevalent among investors, the talking heads we see on TV and read on various blogs, and among the general public. Someone must be responsible for this disaster. We shall find them and they shall be made to pay for their crimes.

I discussed this phenomenon on pages 54-55 of my book. It is always associated with the emergence of a strong, bearish investment crowd and with the disintegration of the bullish crowd which preceded it.

This is more evidence that the low point of the Crash of 2008 was the 666 level established by the S&P 500 in March of 2009. Better times lie ahead.

The agressive contrarian vs. the S&P 500

2009-07-09T11:35:00.009-04:00

In my book I devoted a great deal of attention to a trading style of the aggressive contrarian. This style involves taking above average long positions at times when bearish crowds are in control during bear and bull markets. Once the market rallies (I explained the specific rules in chapter 11 ) the aggressive contrarian will sell his position back down to normal in a bull market or below normal in a bear market.

As I explained in my book, the aggressive contrarian moved to a below-normal long position, his bear market stance, on November 27, 2007 when the S&P closed at 1,407, more than 5% below its 200 day moving average (red curving line on chart above). After a couple of profitable trades on the long side during the January-August 2008 period the aggressive contrarian came into September with a below-normal long position.

On pages 202-204 of my book I explained how the aggressive contrarian would have dealt with the September-November 2008 crash in stock prices. A bearish information cascade was visible in early October. Since the S&P 500 was trading at least 10% below its 200 day moving average then and since the market had dropped about two months from its previous short term peak on August 11 I explained that the aggressive contrarian would have assumed an above-normal long postions near the 1056 level early in the day on October 7.

This turned out to be a badly timed portfolio adjustment. After a rally from an 839 low on October 10 all the way back to 1044 in only two days the S&P resumed its drop. Its closing low for 2008 was 752 on November 20. During this drop the aggressive contrarian maintained an above-normal long position. Consequently during this 6 week period he underperformed the buy-and-hold benchmark strategy.

On page 204 of my book I explained why I thought the right tactic for the aggressive contrarian to follow going forward was to use the standard exit rule for bear market rallies: go back to a below-normal long postion on the first S&P close that is 1% above its 50 day moving average (the blue wavy line in the chart). This happened on December 16, 2008 when the S&P closed at 913. (I finished my book just a couple of days after the November 2008 low close of 752 in the cash S&P 500.)

The next opportunity for the contrarian trader came in early March of 2009. The S&P had established a short term top on January 6, 2009 at 935. Even at that short term top the average was trading more than 20% below its own 200 day moving average (the red curving line on the chart above). So the aggressive contrarian who was following the rules I set out in my book would only have to wait for 60 days or so to pass and for a bearish information cascade to become visible in the media as the market dropped. At that juncture he would again move to an above average long position.

I track information cascades in my contrary opionion posts that you can find at this link. In particular I want to point out the posts of March 3 and March 6 .

The headlines cited in these posts occurred almost 60 days after the January high at a time that the S&P 500 was trading at least 10% below its 200 day moving average. According to the rules the aggressive contrarian would have been justified in moving to an above average long position on March 9 with the S&P at 677.

As I explained in this post I thought that the rally from the March 2009 lows was the start of a new bull market. With this in mind I think the aggressive contrarian would be following the rules I outlined in my book on page 133 that deal with a rally which is likely to be the first leg of a new bull market. The aggressive contrarian is waiting for a new rally high in the 50 day moving average (the blue wavy line in the chart above) that occurs on or after September 6, 2009. Once this happens he will move back to either a normal or below normal long postion in stocks.

Gloom

2009-07-08T10:56:00.003-04:00

Here is a screen shot from today's Instapundit blog. I am posting it because it gives me a chance to make an important point about investment crowds.

As you know if you have read my book or followed my blogs I think that an enormous bearish crowd developed in the stock market during 2008-09. It is certainly bigger and more unified in its bearish convictions about the economy and the stock market than any I have seen since 1966. Bearish crowds this big don't disintegrate quickly. And the screen shot above is just one sample of the relentless negative story about the economy that is still being told by the media.

Such stories belie the assertions I have heard from bearish market commentators recently that "everyone is bullish and euphoric" about the stock market. The public is decidedly NOT euphoric. Quite the contrary, it is depressed - much more depressed than is the economy, in fact. It will be years before the psychological damage wrought by the Crash of 2008 is undone.

As a side note I might also point out that the "everyone is bullish and euphoric" theme is a typical mistake made by investors who like to think they are contrarians. They seize on whatever evidence they can find that makes their own prejudices a "contrary" opinion. But one must be careful to fade the public, not some small group of professional market commentators. And there is no doubt in my mind that the public right now is extremely bearish.

Crude Oil Update

2009-07-08T10:47:00.003-04:00

Here is an image of today's front page for the New York Times. The headline tells us that Washington's regulators are considering limiting the size of positions taken in crude oil futures by certain "financial" speculators.

This headline goes into my media diary along side the one from two day's ago which I commented on in this post. It is highly unusual for two headlines to appear in the same week, in the same publication, which highlight activity in a commodity market. This one, like Monday's headline, worries about market volatility. Now no one worries about volatility in crude oil when the market is going down. They only worry when it is going up. So these two headlines give the aggressive contrarian reason for thinking that crude oil is headed down to $36 or below over the next few months. It is still a bear market in crude.

A Contrarian Looks at Crude Oil

2009-07-06T10:29:00.005-04:00

Here is an image of today's front page of The New York Times. It is very unusual for a commodity market, even one as important as crude oil, to be the subject of a page 1 headline. So when I saw this I immediately cut it out and pasted it into my media diary.

How would a contrarian trader interpret this headline? Is there an obvious bullish or bearish investment crowd dominating the crude oil market?

The first step towards answering these questions is to look at crude oil's price chart. As I emphasized in my book, this is the single most important clue that reveals whether an investment crowd has formed in any market. (See page 112 of my book. ) I see two important things when I look at this chart.

First, the price of crude oil has doubled in the last few months. This alone makes it highly unlikely that any bearish investment crowd is dominating the market for crude oil. A 100% advance in price attracts bullishly inclined traders and investors, not bearishly inclined ones.

If no bearish crowd is in evidence, then how about a bullish one? Here too the price chart makes me skeptical about this possibility. Firs of all, the price of crude oil has risen for only six months or so, doubling during this time. In my experience this is just not enough time to get a bullish bandwagon rolling. Moreover, you can see from the chart that crude is still well below its all time high of $147 which was reached in July 2008. It is very unlikely that a bullish oil crowd will form unless and until the market approaches that $147 level. The situation now is in marked contrast to that which prevailed back in July of 2008 when crude established its $147 high. I discussed the peak oil crowd and its domination of the crude oil market on pages 23-24 and 70 in my book - those pages were written in late July and early August of 2008.

So right now I don't think the contrarian trader can interpret this New York Times headline as evidence for either sort of investment crowd. Still, the headline is intriguing. A very aggressive contrarian trader who is more concerned with shorter term price fluctuations might see this as an opportunity. Here's why.

The first paragraph of the headine story makes it clear that it is the doubling of oil prices that is the motivating fact for the headline. The article is all about extreme volatility in the oil market, but when it comes to commodities the real concern is upside rather than downside volatility. On page 59 of my book I talked about the emergence of volatility as a sign of the imminent demise of an investment crowd. These considerations all suggest that this headline can be interpreted as evidence for the existence of a bullish market crowd, although not one of a size even remotely approaching the one which dominated the market back in July of 2008.

So I think that a very aggressive contrarian would see this headline as evidence that crude oil is about to drop subtantially. On the price chart above you see the red line which is the 200 day moving average of crude oil prices. It is still headed downward which is evidence that crude oil is probably still in a bear market. In a bear market any bullish investment crowd is likely to be short lived. So the combination of the doubling of price over the past six months, the New York Times headline, and the declining 200 day moving average all point to an imminent drop in crude oil.

How low might it go? Well, since this is still a bear market my best guess would be back to last December's low near $35, if not lower.

A contrarian looks at the bond market

2009-06-24T11:47:00.007-04:00

Back on December 1, 2008 I turned long term bearish on bond prices after being a bull for 27 years! (Remember that when bond prices go up interest rates go down, and when bond prices go down interest rates go up). I regard this call as a quintessential example of the contrarian approach to markets that is explained in my book. Here's why.

The first ingredient of any contrarian analysis is historical value investigation. Where is the market relative to previous highs and lows it has seen in previous years? We have to remember that bullish market crowds are associated with overvalued markets - prices have risen too high. And bearish market crowds are associated with undervalued markets - prices have fallen too low. So if you think you see a bullish or bearish crowd developing you have to check your observations against the position of the market relative to its historical extremes. All of this is explained in chapter 6 of my book.

Now take a look at the first chart above this post. It is a weekly chart showing about 30 months of yield information for the 10 year US treasury note. Back in 1946 long term treasury yields dropped to a historical low of about 2.00%. This should be compared with the all time high in the 10 year yield which was 15.96% in September of 1981. So on December 1 of 2008 it was pretty clear that at a yield of about 3.00% the 10 year note was a lot closer to its historically low yield than to its highest yield. Moreover, it had just broken below its previous low yield point of 3.07%, action that was sure to strengthen bullish opinions. For these reasons alone it made sense to be on the look out for a bullish investment crowd in the bond market (bullish in the sense that it expected prices to go up and yields to drop).

There was a second important element in my historical analysis. As I had pointed out in my long term bond market forecast that I had made in 1982 (see the scan in the post I cited earlier) the cycle of falling yields that started in 1981 was expected to last 30 years, plus or minus a few.
By late 2008 this cycle of falling yields was already 27 years old and getting long in the tooth.

These considerations made me certain that a good contrarian trade was at hand - provided a well developed bullish bond market crowd could be identified.

In late November of 2008 people all over the world were fearful of an emerging depression. The S&P 500 had made a temporary low at 740 on November 21. Flight to quality was the preferred investment mode - people dumped stocks and corporate and mortgage bonds and bought government securities. Buying treasury notes was also a deflation play, one that would pay off big time if deflation set in, a typical accompaniment to depression.

So I thought then that the bullish bond market crowd was strong - it was the mirror image of the bearish stock market crowd. And on this basis I thought it made sense to sell out any treasury security postions I held and move those assest back to cash and to the stock market. This I did.

I thought at the time that yields would drop a little more - I cited the 2.50% level in my December 1 post. As you can see from the chart at the top of this post the 10 year yield eventually dropped as low as 2.04% a few weeks later, but has since risen as high as 4.01%. And I think it will go higher still.

Up to #3,545 on Amazon

2009-06-23T15:00:00.001-04:00

Book update

2009-06-23T14:10:00.002-04:00

Right now "The Art of Contrarian Trading" has risen to #5,349 on Amazon's best seller list, up from #13,299 only this morning! Will we break the #1000 mark?

The stock market crowd

2009-06-23T10:41:00.005-04:00

Chapter 15 of my book is entitled "The Panic of 2008". It documents the enormous, bearish information cascade that progressed through the year. Magazine covers and newspaper headlines documented and amplified investor fears. Eventually a run on the "hidden banking system" developed after the Lehman Brothers bankruptcy on September 15, 2008. Markets around the world crashed and took the world trading system and economy with them.

You can find my real time comments on this information cascade at this link. Every time I imagined the news couldn't get worse, it did. By the end of the year an enormous, bearish investment crowd dominated world stock markets. The vast majority of investors and ordinary citizens shared a very pessimistic outlook for the U.S. and world economy.

I think this bearish investment crowd presents a once-in-a-lifetime opportunity to the contrarian trader. The investment policy for a conservative contrarian is described in my book on pages 129-130. I call it the Contrarian Rebalancing Strategy. At this point in time the conservative contrarian would have a normal allocation of his investment portfolio to the stock
market. In my book I tool the normal portfolio allocations as 60% stocks, 30 % bonds, and 10% cash.

Since a bearish stock market crowd is very much in evidence, the conservative contrarian is now waiting for the 200 day moving average of the S&P 500 to turn upward by 1% from the lowest point is has reached since 2007. As you can see from the chart above (courtesy of StockCharts.com) the 200 day moving average (red line) is still dropping and currently stands at 899. So a 1% advance in this moving average still lies some months ahead of us. When this 1% advance in the moving average occurs I think the conservative contrarian should then put all of his non-cash assets into the stock market.

You may wonder why the conservative contrarian currently has a normal instead of a below-normal allocation to the stock market. I have long maintained that the worse mistake any investor can make is to be underinvested during an extended period of rising stock prices. Such a mistake would cause his investment performance to lag that of the benchmark buy-and-hold strategy. For this reason I think a conservative contrarian should only have a below-normal stock market allocation when there is strong evidence for a bullish stock market crowd. Even then, he should wait for the 200 day moving average of the S&P 500 to drop by 1% before reducing his stock market allocation.

In the present context everything hinges of whether or not a contrarian trader/investor thought there was a bullish stock market crowd dominating the market in 2007. I for one did not and I said so in my book. My media diary did not show any evidence of a bullish information cascade in the stock market. So a conservative contrarian who shared my analysis would have maintained a normal stock market allocation throughout the panic of 2008. (Of course he would have had a substantial reallocation away from bonds and into stocks at the end of the year simply to maintain his 60-30-10 portfolio shares for stocks, bonds, and cash. ) Despite this, he lost no ground to the benchmark buy-and-hold strategy during the panic (cold comfort, I know!).

There were some contrarians who did think a bullish stock market crowd was evident at the 2007 top. If they had followed the moving average strategy described above to reduce their stock market exposure they would have done so on February 20, 2008 at the S&P 1360 level as pointed out in my book on page 190. Right now these contrarians would be sitting with below-normal stock market allocations and would be awaiting a turn upward in the 200 day moving average by 1%. They too would move to an above-normal stock market allocation when this signal occurs.

Problem Fixed

2009-06-19T17:19:00.003-04:00

This url is now back in my control. So I shall be posting here on the application of the ideas in my book which has just been published by Wiley.

Learn To Be A Contrarian Trader

2009-06-13T10:54:00.000-04:00

My book, The Art of Contrarian Trading, was just published by John Wiley and Sons. You can purchase it from your favorite book store by following this link. It is the definitive book on how to apply the theory of contrary opinion to stock market and other financial markets. It is packed with information about crowd behavior in financial markets, ideas about how to turn the crowd's mistakes into profits, traders' war stories, and lots of ideas that will help you move your investment game to a higher level.