So What?

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

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

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

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

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

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

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

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

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

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

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

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 !

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

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

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

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

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

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 ?

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 ?

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

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

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

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

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 !!

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

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

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

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

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

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

Book update

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

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

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

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.