Fading Mass Psychology

May 4, 2001

'Fading the masses' . . . was an expression one regular reader used to describe the stance we took back in March, emphasizing our belief then, that the next meaningful run in the stock market would be to the upside not the downside. That was amidst the rather traditional (unsustainable climactic) behavior of panic selling at that time; a negative capitulation that likely would have automatically turned most guru's bullish at the time (if any technicians got bearish or didn't become enthusiastic, that's puzzling).

Were we early; absolutely, though we had properly captured the January Effect rally before looking for another decline (which briefly was more than bargained for). But it was a tenet here not to respond to a panic (and measured move) into oversold by the renewed embrace of despair, which was so rampant as to be associated with finales. Basically the idea was that anybody who wanted any excuse to sell, had it, just as the Johnnie-come-latelies to the upside, now have to contend with an 'overhead supply' risk, that while not necessarily capable of holding the market back for long, certainly has at minimum added some risk component to chasing prices, after weeks on the upside, in harmony with our March-April-early May game-plan, as updated each day.

Throughout this, we've emphasized that the greatest risk in 2001 was not a new bear move, but an upside 'accident', which we prefer not occur, as the market continue to climb what (for some time now) we've termed a 'wall of worry', that is working great. The (at least short-term ended) T-Bonddecline contributed to our upside confidence (called for a correction in bonds, as long-rates would firm, as regular readers know); a reflection of the (often wise) debt crowd expecting a stronger economy; thus higher, not lower, rates dominating the longer-end of the Yield Curve. Shorter-rates are soft, and should be (those are the ones influenced by Fed actions), which helps stocks too as the diminished yield from money market instruments classically draws sidelined or parked-cash into the market; typically well off the bottom as investors recognize they reacted to what had happened, not anything structurally bearish developing this year.

That's true even when you look at the early March decline, because not only was it a function of nervousness, but everyone was pondering why the Fed didn't move, when we argued they needed to do more with short-term rates, but already had moved, by virtue of the nearly-historical (and borderline hysterical) Money Supplyexpansion. It of course was correct that this wasn't having much impact; how could it amidst what clearly was borderline deflation risk, that had to be worked-through, and bullishness was based partially on faith, that the economy (outside of tech at the time, though we even then were calling for something quite different later this year and next) was not so broadly decimated that it couldn't be pulled through. It just took tons of money and persistency from powers-that-be, and we believed that decision was already made at the time. Clearly it was.

Further, after the last formal rate cut, we suggested the smart thing for the Fed to do was to wait for the S&P (if we were right) to push into the low 1200 plus area, before doing a desired intermeeting cut, and wisely, that's what they did. Probably we get a bit more from them, but now they need to be cautious to become gradualist, since we do not have an implosion risk; there continues to be no major-quality bear argument (and as argued hasn't been since March, which by virtue of the collapse then, tended to eliminate such risks, though as stated, few believed that to be the condition then).

Most recently, we had the emerging debt concerns, which we thought (had we had a default in Argentina for instance) were actually a plus for the U.S. Dollar. And we've felt that there was some risk later this Summer (not yet) with energy-induced worries, but that many were missing the mild Crude Oil roll-over, even before yesterday's API numbers shocked so many with the increase in oil and gasoline inventory, then to top it off we got an increase in Natural Gas stocks, reported today. Without an immediate further surge in Energy, there is really no particular inflation, which helps support the market's advance, and as we noted before for over a month, there is no reason for an additional full-blown test, though of course there will be period consolidations or even an occasional corrections (such as in the ideal manner outlined in last night's DB).

In any event, all of this contributes to what will hopefully be more bad news to come; a continued 'wall of worry' to climb, and the market (over time) continues discounting these negatives. What we don't desire is too much optimism (threads of which are in fact emerging, or threatening to) which galvanizes bullishness; but rather just enough roiling to keep investors (and particularly the mostly-decimated hedge-fund players) sufficiently off-guard, or at least lacking in confidence, to allow this to work higher at the same time (but again, not without pause). If we do get too much optimism, we'll have to indeed, to reflect on our opening remarks, consider 'fading the masses' once more; which of course means the psychological mass of thinking, that tends to be at times (particularly extremes) self-defeating. As far as the majority of investors; those remarks do not refer to investors as a 'mass', because in a bear market (which ended internally months ago) the bears are right, and as ole-Joe once said; in a bull market the bulls are right. It's at extremes that the madness of crowds tends to be off-kilter.

In any event, the real question now, is whether overhead supply is really a constraint to the market, or in a truly extended short-term bullish environment, can it push past the indicated (and in some cases well-watched) resistance areas of the various Index levels. Our hotline, as you know, has been almost continuously bullish for weeks, as has this DB. Our work felt the Bear Trap (spelt with a 'T') was in March, not now, and at the moment the (900.933.GENE) hotline continues it's most recent 1248 S&P long.

Coming into crucial inflection areas this week, we'd assessed Monday's retardation in the afternoon as having had more to do with some minor month-end squaring, plus an initially-repelled breakout above key resistance (the prior recovery highs), but one we forecast would regroup into Tuesday's initial morning's action including early chop for awhile, then climb-out and over that June S&P resistance later on in that day, as it moved into more short-term dicey territory during the course of Wednesday's rally. While both days' close over 1270 is basically right at the highs of both late April, and in the immediate spike-reaction to the last Fed cut in Mid April, we think it's mostly in a (position as relates to future action is reserved forecasts for regular subscribers). In any event there's something to be said about 'fading optimism'; the inverse of March.

Now of course you don't expect an infinite number of thrusts towards surmounting the key levels before the market surrenders, especially in a short-term overbought status that invites a degree of concern, even among optimists. However, we suspect several things; including the Oil drop (which weakened Oil stocks, that are still heavily or big-cap participants in both theDow Industrials and S&P Averages), and the weakness in IBM (IBM), which is also a Dow component, contributed to the disparity between a selection of Averages Wednesday. Not to mention the rotational selling of defensive stocks to buy technology, which is an ongoing affair at the current time. Put together, and you see clearly why the Dow had trouble, while the NASDAQ did not.

Ideally, after this market meandered a bit on Wednesday, pullback somewhat in the Dow, but was much stronger in the NASDAQ, probably needs to shakeout a little to get players nervous, then start new upside tries. Some technicians just now are talking about a bear-to-bull transition; to which we say nonsense. This has been telegraphed for several months, and as it becomes obvious to everyone, we'll have to keep finessing a short-term (potentially spiky) top, but probably nothing more in the near future (again, a 'fade'); if the market permits all this.

Keep in mind (as also noted in the May Letter which I completed Monday night and was posted Tuesday morning), that monetary policy has been favorable for reversing the gloom for months; it just took awhile because of the borderline deflation that was ongoing; which means that had to be absorbed before the markets could flourish. At the same time, the depths of despair had so many investors so gloomy that they did not want to consider the nearly historical expansion of the Money Supply that was at the time ongoing, which (barring complete disaster) had to result in a solid reversal to the upside. Now, we are not getting enthused about the market here particularly. This is the reward for being bullish in March and April, and having faith that the post-rate-cut drops in April would be comparatively minimal, contained and controlled above an important (former resistance) area in the low 1200s, and then built-upon successfully.

For the moment, there is a prevailing view that the market can't even get the old most watched Dow Industrials over 11,000. No problem. We get a little bit overdone in an extension of this rise; pullback maybe just enough to wet the appetite of those skeptic technicians and bears, and later blast on through. And maybe that's the bearish sort of alternative...humor intended. We have in mind thereafter (sorry, must reserve the specific parameters), and then maybe we can speak more about a more meaningful correction; though even that will be in a bullish overall perspective.

While we again noted that these things are not inscribed in stone; that the market's not likely to follow this pattern exactly; though it would be an interesting approach to see, we are not particularly surprised about the irresolute nature of Senior Averages on Wednesday, partially because too many sages thought this was too important a day; so it didn't resolve much for the Averages, while many small stocks chimed-in.

What's terrific about this market remains that sidelined capital generally hasn't moved into the market yet, and the perception that much of the upside is institutional rotation and short-covering. It's a plus; as it means sidelined money is still likely to enter this; clearly well off the lows. Then, with upside complacency likely to return, we'll be lots more open-minded to some new sell-offs, but even then they should ideally be within the cyclical bull market which began internally months ago, in the Averages in March, and which (since mid-March) we have viewed as a bottom, which is behind all of this.

In any event we discussed most of this over the past few weeks, and again in a newly preparing May Letter, and think we've made our points as regards the market, clearly and forcefully in recent weeks that something like this would occur, and again the risk of a hesitation (here) before yet another most bullish upside resolution. Here we are, though the NASDAQ has flourished in this action, while the Senior Averages paused, in the manner described, and we think for the reasons noted (above); nothing else.

In summary . . . analysts and technicians are only now debating whether 'the worst is behind us'; something we have contended since the climactic drop in March, which was going down an what we saw as an unsustainable angle-of-attack, and thus had to lead to a turnaround, which was an historical climax that should have been visible to anyone able to distance thinking from the mass hysteria of that moment. Today we got Factory Orders and the Beige Book reports; both of which are better, but not too good, which is exactly how we want economic data for the moment, as you know.

McClellan Oscillator data is consolidating a bit (breadth and volume criteria are not bad, and were considerably stronger than the superficial Averages on Wednesday as was also the case much of Tuesday) at around +129 for the NYSE, and about +70 (yet another +4 change) on the NASDAQ. We expected both markets to work higher over time still, view periodic corrections along the way as desirable, but realize NY's Mac got a bit extended, which could spike the market in time, for the short run; while the NASDAQ probably would follow on the upside newly, which is what occurred this past day (as suggested). By all means we view subsequent efforts to take the market over short-term resistance as crucial, as first efforts were repelled Monday, reversed and attempted again. We would not overemphasize the importance of this however.

(As of posting time of this excerpt, our 900.933.GENE S&P hotline is flat, but looking to reenter a long-side guideline for a rebound into mid-session, though realizing that most of this week's sharper rally, with the help of intraweek players, is likely behind.) For the moment the proximity of the recent breakout is affirmed; more is on tap for now, corrects after being extended, after many got too excited; ideally then up anew.

According to the Talmud you should keep one-third of your assets each in land, business interests, and gold.

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