Cue The Fat Lady

How is it that very important issues are all but ignored by the markets for seemingly forever, and then all of a sudden they start to matter a great deal? Why is that?

Its a quandary facing disillusioned investors. They are perplexed: A series of risk factors which have long been staring investors in the face are suddenly getting a lot more weighting than they had been. Call it reality’s revenge.

I suspect a large part of the
problem is the market’s illusion of efficiency.
Perhaps over the long run – you know, the long run in which we are all dead – the
market is mostly kinda efficient. But over the short run, it is quite apparent
that markets are hardly very efficient at all. And has been famously observed,
their capacity for staying irrational is far greater than your capacity for
staying solvent. Hence, the importance on waiting for clear signals to short tops
and buy bottoms, rather than merely guessing.

That’s where we now find
ourselves. The four year Bull market which traces its start to the September 2002
lows and pre-war March 2003 retest is now getting quite tired. We see continued
warning signals that it is running out of fuel. As the technical signals
accumulate, a plethora of risk factors are coming home to roost (all bird flu
puns aside).

Since investing is all about
getting paid for taking risk, it behooves us to understand when it is more or
less rewarding to assume that peril. John Hussman astutely observes that “risk tends to be unusually rewarding when
market valuations are low and interest rates are falling.”
The opposite is
also true: “Market risk tends to be
poorly rewarded when market valuations are rich and interest rates are rising.”

Long term investing success comes from correctly identifying which of these ecosystems
we are in.

Hence, all the recent turmoil. I
suspect we are now in a transition period, where the ability of the masses to deny
what a few have recognized can no longer be sustained. Our collective capacity for
self-delusion is great, and markets are merely a collection of Humans. Eventually,
the market – us imperfect Humans – start to recognize what has been staring us
in the face the whole time. We adjust our holdings, reduce risk, and shift
assets accordingly. That process is now well underway.

Its worth watching the
leadership of the bounce (whenever it finally gets here). Look to see if the traditional
safe harbors outperform: watch defensive plays, like Bonds, Utilities, Big
Caps, even Food and Beer stocks. As the reality of this aging Bull settles in
risk appetite will shrink.

Look for a run up towards recent
highs – that’s where your shorting opportunity will be
. As too few traders really
know, Patience is called for. We expect it will be rewarded.


UPDATE: May 27, 2006 9:28am

I just noticed that swingtrader and author Alan Farley is also looking for a run back towards the highs this summer:

Summer Rally?   5/26/2006 4:17 PM EDT

Folks pounding the tables about lower prices ahead might want to take a look at the weekly closing bars on the SP-500, Nasdaq Composite and Nasdaq-100. They are very bullish and even suggest that a test of the 2006 highs may on the agenda this summer. Go figure.

Good company. As mentioned, Farley was one of the few who avoided the falling knife catching fever.

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What's been said:

Discussions found on the web:
  1. S commented on May 24

    I believe many market participants fully recognized the risks they were taking. Partly due to pressures to put up good performance numbers, but mostly due to arrogance and huge egos, most of those people felt they could exit unscathed, or nearly so, once they sensed the top.

    The market has an amazing way of humbling people.

  2. Mark commented on May 24

    There’s going to be a rally?

  3. Ned commented on May 24

    I find myself in agreement with Mark (again) as this market seems very weak and looks like a dead tired cat.

  4. GRL commented on May 24

    These last two weeks have been a Godsend.
    Sold out my NDE, and have just bought it all back for less. Yes, I could have waited, but no need to be greedy. (Who knows, maybe mortgage apps will come in higher than expected and spoil the party.)
    For good measure, I also bought some MTH (before new home sales came out this morning), another well-run company in a sector that is hated.
    My one mistake in all of this was buying ESLR a few days ago. I got killed on that one.

  5. KirkH commented on May 24

    GRL, have a look at this:
    “The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity for the week ended May 19 decreased 6.0 percent to 552.6 from the previous week’s 588.0.
    The MBA’s seasonally adjusted purchase mortgage index fell 7.1 percent to 396.4. The index was also below its year-ago level of 482.3.
    The purchase index is considered a timely gauge on U.S. home sales.”

    6% in a week?! Maybe it’s just volatility. The home sales numbers are a month old morbidly rubbery feline in my opinion.

  6. Groove commented on May 24

    We’re due for another circuit-breaker day. I’d like to pick up some Intel cheaper than this.

  7. Bynocerus commented on May 24

    Danger Will Robinson

    JJC has a new posts suggesting that it is now time to sell stocks. Remember boys and girls, this is the man who capitulated in ’98. Today looks like it could be setting up a gorgeous fractal for tomorrow, so all of us hogs (let’s face it, if you’re margined and you’ve been short since May 10, you’ve made it a hell of a year already) need to be wise.

  8. B commented on May 24

    As cheap as Intel might look, remember the PE was 9 in 1990 and its growth was yet ahead of it with the proliferation of the net and the PC. The PE ain’t 9 and unless earnings are going to expand………..The semi industry has just announced world wide demand is dropping and recent semi results may have reflected channel stuffing……….I think you might find in the 2 half that earnings and revenue crater even more. The stock is partially bouyed by buyers who believe they’ll get the benefit of a pickup in demand in 2nd half………..what happens if they don’t?

    Might be a good buy or might head back to 2002 low over time.

  9. Mr. Beach commented on May 24

    What is that statement about the ‘Triumph of Hope Over Experience’…..

    Barry — you nail it here. For some reason, markets and market observers are unable to recognize trick waters. Whether it is the euphoria in emerging markets (Bombay Stock Exchange 52-wk: 6,522.80 – 12,671.10) or it is the euphoria in housing or the euphoria in junk bonds.

    Martin Wolf has a great column in the FT:

    He refers to a paper that basically argues that the Greenspan Put has lulled investors around the world.

    Has macroecon fundamentally changed? Is asset price inflation a bigger worry than consumer price inflation? Do central banks exacerbate the problem through asymmteric responses: slow to raise, fast to cut?

    Cheap money — amplified through asset price inflation — is it a great thing or a dangerous thing?

  10. GRL commented on May 24

    KirkH — I meant existing home sales, due out tomorrow, not mortgage apps.
    But, based on mortgage apps, it could be that existing home sales turns out to be a bummer.

    BTW, how about that Vonage IPO?

  11. Bynocerus commented on May 24

    That should be post, not posts [sic]. Subject verb agreement is fun-damental.

  12. Groove commented on May 24

    I’d love to get INTC at a P/E of 9, but I’m not sure it’s gonna happen – if it does, I may back up the truck. I’m looking at it as a weak dollar play with some 70% of revs coming from overseas (I need to verify this). I don’t care much about a temporary drop in demand, as this would be a long-term buy. Looks cheaper than ’02 to me here, and it’s getting cheaper all the time – I’m hoping for 15 or so.

  13. GRL commented on May 24

    Boy reading that BIS paper underlying the Martin Wolf article linked to above, it sure sounds like a point by point refutation of everything Helicopter Ben stands for. From the Intro:

    It will be argued in this paper that price stability is indeed desirable for a whole host of reasons. At the same time, it will also be contended that achieving near-term price stability might sometimes not be sufficient to avoid serious macroeconomic downturns in the medium term. Moreover, recognising that all deflations are not alike, the active use of monetary policy to avoid the threat of deflation could even have longer term costs that might be higher than the presumed benefits. The core of the problem is that persistently easy monetary conditions can lead to the cumulative build-up over time of significant deviations from historical norms – whether in terms of debt levels, saving ratios, asset prices or other indicators of “imbalances”. The historical record indicates that mean reversion is a common outcome, with associated and negative implications for future aggregate demand.

    Great lead.

  14. Bear Mountain Bull commented on May 24

    Reality Bites

    Barry Ritholtz at The Big Picture wonders why, all of a sudden, the risks that many of us have known were out there have started to matter to the markets:
    How is it that very important issues are all but ignored by the markets for seemingly forever, an…

  15. BV commented on May 24

    Intel is looking good to me. They’ve got new fast chips, no longer trailing AMD, and just about everybody will need to upgrade to run Vista. Plus they’ve got Apple on board as well. On the server side, the new virtualization extensions are going to drive a whole lot of new demand.

    I just wish they’d kill Itanium.

  16. sam commented on May 24

    intel is losing to AMD…17 looks good only on paper…will look better at 9.

  17. John Navin commented on May 24

    Food and beer stocks indeed. KO had a great day. The BUD chart looks decent. Did I see Campbell’s Soups showing up on the new highs list?

  18. Bastiat commented on May 24


    No, Intel has been behind in terms of tech application since 2004 and they haven’t caught up.

    AMD has broken Intel’s monopoly as suppliers to Sun, Dell, HP, and IBM.

    Intel looks like their going to be firing employees,
    while AMD is hiring,

    Both companies have Virtualization tech; AMD V & Intel’s VT.

    They haven’t gotten rid of the mindset that lead to the Itanium and that’s why they’re going to be punished further.

  19. Alaskan Pete commented on May 24

    I know for a fact that Intel has had a hiring freeze on for many months and will start lay offs within the next two quarters.

    Used to live in the PacNW and still have alot of friends who work for Intel out of Portland, OR.

  20. Chris commented on May 24

    Anyone care to comment on what to expect with GDP numbers and stock market reaction ?

  21. jcf commented on May 24

    Byno — Your “posts” was an object and gets along just fine with the verb but does have an agreement problem with its article.

  22. DBLWYO commented on May 24

    Speaking of reality checks – first let offer Barry a BZ (lookup Navy slang) for one of his better obs but more so for the (or as well) for the Fischer and Hussman posts.

    Continuing but veering into other Realities the boating community has been cutting back motoring for the last 3-4 years but especially severely in ’04/’05 they’ve just been sitting at the dock, even when they had slips. Now my favorite Sound chain of marinas has slips available at most of their yards. If you aren’t part of the game you may not now that over the last several years they went from closing them out in April to closing out avaibilities in mid-Jan.

    Think of these as both 2nd home indicators as well as dispoable spending indicators. There’s serious breakdown on the fringes of the economy and it’s just showing up this last winter and early Spring.

  23. john commented on May 24

    DBLWYO – is that a good thing or bad? I think the price of gas coupled with the fact that there just ain’t no place to go keeps most of the dock queens at home. Everytime I cross the bay (Chesapeake) I see plenty of sail and small craft. The medium size diesel hogs just stay in port except for special occasions.

  24. DBLWYO commented on May 24

    Well we sailors think it’s a good thing but my motoring friends and marina neighbors thought it was a very bad thing.

    However for usn’s here that for the first time in nearly five years demand for slips has dropped so suddenly and precipitously w/o warning that they’are still available at the largest New England operator is a scary mine canary for what’s ahead for the economy.

    At least that’s my trial balloon.

  25. Mark commented on May 24

    Lowry’s still reporting new highs for selling pressure and new lows for buying pressure according to R. Russell (who knows a thing or two himself about markets). So how do we rally? Even today MORE LOWS THAN HIGHS.

  26. jkw commented on May 24

    It’s possible that the lack of strong selling at the end of today means that the derivatives/margin call problems have been worked through. Which would mean that a rally is more feasible now. If the problem was derivatives/margin calls.

  27. ndk commented on May 24

    Liquidity is a directional process, and we are in an asset economy. NOTHING matters except LIQUIDITY. After receiving a margin call, most people aren’t extremely eager to increase their exposure. Who’s the borrower of last resort now?

    I don’t see a bounce in the offing for quite some time, to be honest.

  28. dave wichman commented on May 27

    The historical precedence of the stock market is more important than any technical analysis. This late in the game a wise investor should have sold into a cash position May 11th. I’ll take 4-5% for the near term and build a principal waiting for the inevitable and relatively near term 10-20% correction. If I lose 10% on the upside from here I’ll more than break even when the buying opportunity of a decade is revealed.

  29. Jim Brown commented on Jun 14

    please post me top lady pictures

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