I' mmmmm baaack!

It's been more than a year since I have updated this blog. I have been dealing with a number of personal issues and consequently updates for this blog have been low on my list of priorities. Of more significance is the paucity of contrarian material in the news media over the past year. There have been lots of economic and political headlines but none directly mentioning the markets. So it has been hard to identify any new bullish or bearish information cascades.

I want to point out one change to which we contrarians will have to adjust. The print media, the mainstay of my approach to identifying information cascades, are rapidly declining in significance relative to electronic sources of information. This is going to make it harder to identify information cascades, especially the bearish ones which typically come and go quickly. As a concrete instance of this trend one can point to the demise of Newsweek's print edition. Time magazine is evolving into a tabloid and so I think its usefullness is diminishing too.

A big part of the art of investing, and particularly of contrarian investing, is the ability to adjust to changing circumstances and market environments. So going forward I will be trying to incorporate more electronic sources of information as indicators of market sentiment to supplement my readings of newpaper headlines and magazine covers.

My last post on this blog was in December 2011. In it I said that pessimism about the US and European stock markets was thick and that this meant that higher prices were ahead. A few days after that post long term contrarian traders were confronted with a mechanical sell signal on December 20 in the S&P 500 when its 200 day moving average dropped 2% from its high point reached earlier in 2011 (chart is above this post). I personally ignored this signal as a matter of contrarian logic - if pessimism dominated the markets at the time then this sell signal would turn out to be wrong (and it was).

There were other technical reasons to doubt the signal. First, the Dow industrials never got even close to generating a similar sell signal. Secondly, when the S&P's 200 day moving average achieved its 2% decline on December 20 the S&P was actually above its rising 50 day moving average (wavy green line on the chart above). At the very least this would have been reason to delay acting on the mechanical sell signal. The next time the S&P traded below its 50 day moving average was in mid-2012 after the 200 day moving average had resumed its strong up trend.

Aggressive contrarians had abandoned long positions in late August 2011 near 1200 in the S&P. Needless to say I repurchased my own aggressive contrarian long position on the one day dip right after Christmas of 2011 at about the 1255 level. It has remained undisturbed since then.

At the top of this post is an image of the January 26 front page of the New York Times. For the first time in a very long while there is a headline about bullish stock market performance pointing out that the S&P has closed above the 1500 level for the first time in five years.

Is this a sign of a bullish information cascade? I am doubtful about this possibility. I think the man on the street is still pretty much out of the stock market and pessimistic about the US economy.

Nonetheless, one must recognize that S&P average has been moving generally upward for 46 months, an unusually long time for a market advance. And the average is approaching the levels of two big tops at 1553 in 2000 and 1576 in 2007. There was a lot of pessimism around at the time of the 2007 top. This fooled me then into thinking that the worst that was likely on the downside then would be a 20% or so drop.But things got a lot worse than I imagined they could.  I don't plan to make this same mistake again. This is another reason for contrarians to take the headline above this post as an early warning of a possible storm ahead.

I think that both conservative and aggressive contrarians should now be looking for reasons to reduce the size of their long positions. Personally I think the advance from the November 2012 low point has further to go. I am looking for a move up to 1546 in the S&P. Once the market gets there, or if other bearish signs develop in the interim, I think it will be appropriate for aggressive contrarians to cut way back on their long postitions.

Conservative contrarians dodged a bullet in December 2011 when the S&P generated a mechanical sell signal which I ignored. I think it will be appropriate to take advantage of this fortunate circumstance to sell long positions at the same time that aggressive contrarians do even though this would violate the mechanical guidelines for conservative contrarians whichI set down in my book.

I will keep you posted on my thinking about these possibilities going forward.

what hasn't happened

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 that 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

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

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

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

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

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.