THE Most Frustrating Time To Be A Sensible Investor
Graham Summers
September 23, 2009
Market tops are THE most frustrating time to be a sensible investor. Common sense and analysis tell you that the market is out of control and running on thin ice… but as investing legend John Templeton put it, "the market can stay irrational a lot longer than you can stay solvent."
Indeed, tops are only formed after periods of prolonged irrationality. And once you attain a state of mania (a time when stocks are completely detached from reality) even minor announcements (or outright bearish announcements) can be spun to look bullish and help stocks eek out a few more percentage gains.
Consider today's market for example. Over the weekend, China and the US announced an informal trade war (each country placing tariffs on the others' exports). This is HORRIBLE for the economy and stock market (it's also an eerie repeat of the '30s situation in which a trade war prolonged and protracted the Depression). And yet… stocks managed to rally on Monday because President Obama presented a speech to Wall Street executives about "doing the right thing."
Let's consider this for a moment. The impact of an actual economic reality that is HORRIBLE for stocks was eclipsed by a political figure (who's failed to reform anything) lecturing the perpetrators of the biggest Financial Crisis in history on reform. This would be hilarious if it weren't real.
Now, market tops are typically marked by desperation, meaning that market participants become desperate to cling to the "bull" story in the face of worsening realities. This desperation involves:
- Virtually any and all news is being spun to sound positive.
- Negative economic realities being hidden by accounting gimmickry and adjustments.
- Negative news articles being buried on the back pages of financial journals.
- Negative economic announcements being released after the market closes or on weekends to mitigate the impact.
- A major political figure announcing that danger no longer exists or that things will continue to be positive for as long as one can forecast.
- The average uninformed investor believing that things have "recovered" or "changed" to the point that downward risk no longer exists.
This defines today's market action to a "T." Every announcement played over the airwaves is spun to sound positive (Obama's speech to Wall Street was naïve at best, hopeless at worst and yet the market rallied on it). Seasonal adjustments mask economic realities (REAL job losses in August were OVER 1 million). News articles on bank lending contracting or other items of note are relegated to page 10 of the Wall Street Journal.
We also see economic announcements of import coming after the market's close or over the weekend (see the trade war between US and China), and several political figures (Obama and Bernanke) proclaiming that the worst is over and that the recession has ended respectively.
On a final note, the people I know who don't read any financial news at all have begun telling me that the stock market will keep going up. They never have any data to support their views but merely point to the parabolic move in the S&P 500 over the last month. They ask me why I'm so gloomy. When I'm done talking they always appear depressed.
In a nutshell, sentiment-wise, we are right back to Autumn of 2007: a time when fundamentals, qualitative insights, and economic realities meant NOTHING to stocks. It's extremely difficult to keep your head in these environments because nothing makes sense anymore.
Where the Market Will Head From a Technical Standpoint
The below chart shows the S&P 500 with its 21-day, 55-day, and 126-day moving averages: typical metrics used in technical analysis.
As you can see, stocks broke above the 21-DMA in mid-July and have stayed there throughout this rally. The brief corrections in August and September (when we went short) involved tests of the 21-DMA, but stocks quickly turned around and rallied higher.
This tells us that the upwards momentum here is strong (or at least involved massive short covering). The fact that we've also seen a new higher low (when the market bottoms at a higher level than its previous bottom) in September vs. August tells us that the market's trend remains upwards.
From a larger perspective, the weekly chart of the S&P500 is closing in on its 88-week moving average. This is critical because the 88-weekly moving average is THE defining metric for bull vs. bear markets.
As you can see, the bull market from '03-'08 was signaled by the S&P 500 breaking above this marker. Also note that the market was turned away from this line in early 2008, which marked the beginning of a prolonged and severe downturn.
If the market can clear the 88-weekly moving average (1,076) in a sustained way, then we are indeed on our way to a new bull market (albeit after some kind of consolidation period). However, if the market is turned away at 1,076 (the 88-weekly moving average) then LOOK OUT BELOW.
Given the market's recent upwards momentum, we may see a break above the 88-weekly moving average. But the market needs to STAY there for this to be a genuine move (see the mid-2003 consolidation period that heralded that move). Rest assured, I'll be keeping my eye on this chart closely going forward.
On a final technical note, the S&P500 has begun to form a rising "bearish wedge" pattern. This occurs when a trading range shrinks as stocks rise higher. The rising bearish wedge pattern is extremely important to note because these patterns typically preceded SHARP moves downward.
As you can see, stocks have just touched the upper range of this pattern indicating they are overbought in the near term, which forecasts a brief correction or cooling period in the short-term.
The fact that we are seeing one of these patterns form at the same time that stocks are nearing their 88-weekly moving average indicates that we could see some REAL fireworks within the next two weeks. If stocks break the bearish wedge around the 88-weekly moving average (1,076 on the S&P 500) we could see a SEVERE downturn shortly thereafter.
To my way of thinking, all of this is evidence that stocks could be in for a nasty collapse very shortly (within 1-3 months). However, given the short-term upward momentum, we could see the S&P500 go as high as 1100 or even 1,150. As I mentioned before, tops can take a lot longer than expected as the mania peaks.
So how do you know when it's over and it's time to sell? I'd count any of the following three items as an official "Sell":
- Stocks break below the Bearish rising wedge pattern
- The S&P500 is rejected at the 88-weekly moving average and moves sharply down
- The S&P500 breaks below 1,000 and then 980.
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Good Investing!
Graham Summers
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