Friday, January 14, 2011

Market Musings: Stay in Your Comfort Zone

I have presented a lot of data and studies over the past couple of weeks suggesting that the equity market could go this way or that way.  I can make the bullish case for "this time being different" or I can make the bearish case for an intermediate term top.  It isn't a matter of data mining, but just how the models and strategies are coming together.

The bullish case was made for the NASDAQ 100, and it is based upon this notion that it does take bulls to make a bull market.  So while sentiment is extremely bullish, that's a good thing and is typical of the 1995, 1998/99, 2003 and 2009 bull market runs.  The only problem is you won't know until you get there, but the current set up has the technical characteristics up those noteworthy market runs.

The bearish case is really for the S&P500, and it is basically comes down to the fact that an overbought, over bullish market where there are rising trends in gold, crude oil and Treasury yields is at risk for a correction.  These are major headwinds even during the "go - go" years of the 1990's.  This model generated a sell signal back in November, 2010, and the market has continued higher.  It is worth noting that the current price move since the sell signal is within the expectations of past sell signals.  This is no big deal.   

So one sell signal and one buy signal and in two highly correlated indices to boot.  Both are strategies that I have absolute conviction in as both make sense to me.  The market is never easy or straightforward.  How do I deal with it?

Before answering that question let me mention that this market environment is highly unusual.  For example, I have seen two studies this past week suggesting how unusual things have gotten.  Bespoke Research had an article entitled, “Down Days Disappear”, and in the article, they note that “the Dow hasn't had a 1% down day since before Thanksgiving, and Monday's 0.32% pullback is the biggest decline the index has had since the start of December.  It is nearly unprecedented to go this long without having a one-day decline of at least one-third of one percent.” had their own version of all the goofiness, and they had research showing that the S&P500 has gone for 30 consecutive days without closing below its 10 day moving average and this has never happened in 88 years!!!  Similarly, I presented some research last week to our Premium Content subscribers showing the paucity of short term buy signals in the Rydex data over the last 4 months and how this was different from past bullish runs in this decade.

So back to our question: How do I deal with it?   For myself, I always think in terms of my comfort zone and reward to risk.    I am not a proponent of chasing momentum as it is not in my comfort zone. So if you don't want to chase momentum, then I can see doing two things: 1) find some other sandbox to invest in --- some place where the raward to risk is better, and I have suggested oil, treasury yields and platinum; or 2) bet against the market once the "this time is different" scenario is no longer in play as this has the best reward to risk.

As chronicled above, the market is going up day after day after day.  I don't view that as a sign of strength.  I view it as dysfunction.  A market that fails to correct isn't healthy.  Few things in life when taken to the extreme are ever good for you, and the markets are no different.  I suspect - and it is only my gut - that the extremes we are seeing in sentiment and price will lead to a correction and a better buying opportunity in the future.  Something about this market advance doesn't feel right.   



bmbull said...

Straight up never 'feels' right -- but always lasts longer than I think it will.

I enjoy reading your thoughts -- thank you for sharing them!

Guy M. Lerner said...


Thanks -- I would concur but the whole thing seems dysfunctional; if there was a reason to be long other than the "Bernanke put" I would certainly embrace the bullish EQUITY cause; it would seem that the market is ahead of itself but this is nothing new.

bmbull said...

Well, I think it IS dysfunctional. But the big banks feel they have nothing to lose, and everything to gain, because Ben will always have their backs. And so far, that's been true. However, if that continue, it will end up costing us all dearly down the road. The 'Bernanke put' may have grown to be much worse than the 'Greenspan put' ever was.

At least that's the way I see it.