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.