Blood in the water?

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

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

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...

... 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

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

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

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."

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By the way, the article appeared in the September 28,1992 issue of Time. Thanks to Professor Mark Perry for the link.