Correction’s Impact on Sentiment


What did this week’s whackage do to market sentiment? What might that mean? Alan Abelson gives us the skinny:

"Nothing better illustrates how vivid an impression
Tuesday made on ordinary Janes and Joes than the marked change in their
sentiment as registered by the American Association of Individual
Investors: to 39.6% bearish and 36.6% bullish, from 53.9% bullish and
22.3% bearish the previous week.

By contrast, the Wall Street seers remain stoutly
upbeat. The conventional view (wisdom is too fine a word for it) among
strategists of various shapes, sizes and dispositions is that the
market was obviously overheated and primed for a shakeout.

They didn’t bother to offer it, but the implicit
excuse for not sounding the tocsin before the big break was they were
too busy crooning on about Goldilocks, the global savings glut and the
sea of liquidity as guarantors of the Dow climbing to (insert here the
wild number that makes you happy). In any case, no need to fret.

For the market’s getting creamed is a healthy thing.
It shakes out the froth (that’s you they’re talking about) and sets the
stage for another, bigger and stronger dash upward. So goes the
post-meltdown mantra of the chronic bulls.

The almost universal conviction is that Tuesday’s
plunge was not the start of a full-fledged bear market. Even the
savviest sage we know, who has been unequivocally skeptical for a spell
now, thinks the odds are against it being the start of a bear market.
He reckons there’s one more big move up likely and, after that, perhaps
a few month hence, stock prices will begin their journey to the nether

Perhaps. But we wonder. That virtually everyone
agrees that Tuesday wasn’t the start of a bear market strikes us as
more than reason enough to suspect it just might be.

That’s pretty consistent with my view:  More volatility, rallies towards prior peaks that fail, leading to deeply oversold conditions, new lows and eventually, new highs. (YMMV).

Note also that Barron’s "Up and Down Wall Street" column picks up the Albert Edwards quote we highlighted last month (via Bill King) . . .


Bear Market, Anyone?
Barron’s, March 5, 2007      
Up and Down Wall Street

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What's been said:

Discussions found on the web:
  1. Rick Hanley commented on Mar 3

    I’m sorry, this is a new topic, a quote from Bernanke.

    Bernanke: “…leverage over …key asset prices.”

    Bernanke Says Globalization May Push Inflation Higher (Update1)
    By Craig Torres and Vivien Lou Chen
    March 3 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke said increased global links between economies may have helped spur U.S. inflation.
    Booming demand for energy and commodities by China and other countries has contributed to the surge in their prices in recent years, Bernanke said in a speech at the Stanford Institute for Economic Policy Research in Stanford, California, late yesterday. This dynamic may offset the effect of trade in slowing price increases on manufactured goods, he said…
    …Bernanke, who started his academic career at Stanford, said growing foreign ownership of U.S. debt hasn’t eclipsed the central bank’s ability to determine interest rates.
    “Given their scale, capital inflows and outflows certainly influence long-term U.S. interest rates and other key asset prices,” Bernanke said. Still, “the Federal Reserve retains considerable leverage over longer-term rates and key asset prices.” (1)

    (1) What does this mean? Is this what he meant to say?

  2. S commented on Mar 3

    I read the “Ten Reasons” article on Very nice job. The one thing I wonder about is the comment about the FED’s reluctance to cut rates because of elevated inflation. I sense a whole lotta deflation may be about to smack us.

    The sub-prime and Alt-A lenders will be unable to restructure repayment plans with everyone in default. Therefore, they’re going to experience a spike in the number of houses they are long at a time when inventories of both existing and new homes are still high. They won’t want to incur the carrying costs of insurance, taxes, maintenance, etc required to be a patient seller. They’ll be motivated sellers. With homeownership rates near record highs, and lenders tightening lending standards, the pool of qualified and willing buyers is unlikely to be large enough for the lenders to move the repossessed homes without taking a serious haircut. So the lenders who repossess and unload without regard for price will effectively force the consumers and builders with inventory on the market in those neighborhoods to revalue prices lower.

    I think many consumers, who are already overloaded with debt, will respond by cutting back on spending. So the deflation that starts with housing (and autos) I think will spread as businesses cut prices in an attempt to induce consumers to spend. And this comes just as unemployment is about to start ticking up from construction layoffs, magnifying the deflationary effect.

    The people who are worried about sub-prime don’t talk about the impact of the potential supply shock of more homes about to come on the market in the next few months. I hope I’m wrong and more of the lenders and defaulted borrowers will be able to come to terms. But if the lending was as negligent as often reported, it seems like wishful thinking. In that case, I think the FED is going to start aggressively cutting rates soon to stave off deflation. But wait, the FED can’t cut rates. Doing so will risk a run on the dollar by the Asians and Arabs. What’s a Fed chairman to do with this pickle?

  3. diva commented on Mar 3

    Well, I think the sell-off has a pretty simple origin: time to raise cash in order to pay 06 taxes.
    So…. the markets should recover nicely in April.
    We shall see….

  4. lurker commented on Mar 3

    The idea of the market “forecasting” anything is misguided, in my view. I think the market tries to discount the risks of possible future events. The recent sell off is the market looking a higher chance/risk that Goldilocks might get mauled. If that is the same thing as predicting perhaps it is all a semantic quibbling, but reweighing the odds is the way I like to think about it. FWIW.

  5. DD commented on Mar 3

    Another Abelson/Ritzholtz makeout session…?

  6. Frankie commented on Mar 3

    Hey Barry…let’s take a peek at good old Alan Unableson’s piece from March ’03..the Duct Tape Bottom. I’m sure he was snarking the same drivel. He prolly “saved” many readers from some out sized profits then too.

  7. Barry Ritholtz commented on Mar 3

    Understand what Abelson’s role is as a commentator: He is an alternative to the relentlessly cheerful Wall Street bullshit & hype machine, and the media outlets they suck into their maw.

    He isn’t a trader or a finacial advisor: He is a counterweight to the sunshine squad.

    Find me someone who lost money due to Abelson, and I will show you an idiot . . .

  8. Ralph commented on Mar 3


    At the moment, just about every sector that we track is down since the free fall on Tuesday, on a breadth and price basis. A few very specific groups have shown some resilience on a breadth basis, such as oil & gas pipelines, building materials wholesale, personal computers, health care plans, etc..

    On the downside we see some larger type groups taking the brunt of the selling on a breadth basis, such as Biotech, Homebuilders and Semiconductors. We do believe there is more downside to come, at least until things appear more clear from China. At that time we will be bargain hunting aggressively.


  9. Philippe Rafat commented on Mar 3

    A market price too soon or too late ?

    Goldman, Merrill Almost `Junk,’ Their Own Traders Say (Update2)

    By Shannon D. Harrington

    March 2 (Bloomberg) — Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

    Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody’s Investors Service. For Goldman, Morgan Stanley and Merrill that’s five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk

  10. Jdamon commented on Mar 3

    Barry, while I really love coming to this site and reading all the info, as an investor, I am all about not losing any money, but I also need to MAKE some money now and again. You have given us a million reasons to not buy stocks, but what the heck can we buy to MAKE money?

    Negative article after negative article only seem to show you are a perma-bear. My question to you is can you tell me when you weren’t a bear and when you actually liked stocks as an investment? Where you bullish in March ’03? I would like to see some pieces you wrote then because I have NEVER seen a postive piece about the market on this site (been coming here for about 8 months).

    No disrespect intened, I really love your commentary and this site, but I’m just starting to wonder if you are a perma-bear or a very insightful guy.

  11. OldVet commented on Mar 3

    I love to listen to the Sat morning Fox market hype, but who I really think has something to say are people who understand what the mortgage/MBS/credit-default risks are. All those bad loans to people who couldn’t afford them, to buy houses twice as big as they needed, where they could put all the Chinese junk they borrowed to buy. Did you really trust real estate salesmen to explain all this to Wall Street?

    When the little local banks and pension funds and others who bought the MBS that the national and regional banks were churning out start complaining, watch out. You bought it, you own it. Who guaranteed the risk? See comment above this one. Our banking system is going to vibrate in 2007, and the Fed is going to have its hands full, IMHO.

  12. Eclectic commented on Mar 3

    Thanks for the kindness, and respect… I got to do double duty. It just gave me a moment of eye-socket w-h-i-p-l-a-s-h!

  13. zell commented on Mar 3

    Come on, Jdamon. There are plenty of stock pimps out there who can tell you how to m”make money.” The Old Vet is right. I like the “vibrate” concept as everyone should be feeling them as they continue to build…the thunderbolt will come in the MiddleEast before summer as I’ve said before…regarding Israel and Iran. That heat was turned down well before the election and is now steadily increasing.

  14. Teddy commented on Mar 3

    Great post by Rick Hanley above wherein Ben states that the Fed “retains considerable leverage over longer-term rates and key asset prices”. I think a lot of people would have guessed asset prices, but longer-term rates? What is the mechanism and is M-3 involved? And note that he uses the word “leverage”.

  15. Craig commented on Mar 4

    JDamon: Maybe you need to get off some of your gold and subscribe to the marketletter instead of sniping the host of this free site for his free info.

    I’m a subscriber and since I subscribed (2 mos.) I’ve made many times my investment before this correction on a couple RR&A ideas and I took said profits due to alerts from Barry starting in January. More precisely, several alerts Monday before the Tuesday sell-off.

    Some say it’s better to be lucky than good (?) but since I’ve seen all the markeletters and alerts and the info that never makes it to the blog I know it isn’t luck that Barry predicted this correction. He also suggested several methods for taking advantage of it or hedging long only accts depending on ones approach with plenty of time before the correction.

    If you subscribed you would be making money right now. I am.

    Thank You Barry.

    This post is unsolicited and I have no interest of any kind in RR&A.

  16. mark commented on Mar 4

    j damon….the purpose of this blog is not to provide you with trading ideas. Its commentary and opinion. and it makes for interesting discussion. but dont trade off any opinions expressed here. I was in the barber shop this week and believe it or not someone mentioned this blog. it truely does make grist for discussion. the big picture is just that, very BIG. call merril for tading ideas.
    like many permabears, this correction was predicted for two years running. we all knew eventually, all those calling for a correction would be right, sooner or later. nothing special there. but remember while all those bearish pundits were saying the sky was about to fall, the market climbed 16 percent in 2006 alone. silimilar to 96, 97 when the market was so over extended, and all the permabears where calling for a crash. what happened? they missed out on the biggest move in the history of the markets. Eventually all the permabears will be vindicated but not before they have missed spectacular moves, if not severly dented bottem lines by taking action on their convictions. this big picture economy stuff is all very anecdotally interesting, but if you have to wait 2 years for the big one, or every seven or so years in alan ableson’s case, whats the point? I may be in a nursing home before ableson is vindicated once again. and he will be, no doubt.
    be nimble, follow the trend, be true to your charts because when it comes down to it, no one knows what tomorrow will bring. anything can and will happen.

  17. Frankie commented on Mar 4

    “Find me someone who lost money due to Abelson, and I will show you an idiot . . .”

    Lost money?…if you listened to him, you would never have been in the market to begin with…so you’d have no chips to lose.

    Ableson is a characture of himself. He is fun to laugh at…not with.

  18. Frankie commented on Mar 4

    No hype or cheerleading…just STATS:

    In the 38 times since 1979 that the S&P 500 index took a single-session hit of 3% or more, the next 60 days has seen the index up 31 times, with an average gain of 6.9%.

    Private equity groups, sitting on record levels of cash and encouraged by seemingly endless low-cost financing, are likely excited by the opportunity the drop creates. Byron Wien of Pequot Capital still thinks the S&P could hit 1,600 by year-end, and says equities’ 7% earnings yield compares favorably with the 4.5% yield on 10-year T-notes. Risks to the stock market include a slowing economy, global unrest, and weak earnings growth. But an economic slowdown could also be a boon if the Fed drops its rates down to 4%, a number some economists see by year-end

    -From Seeking Alpha

  19. Guy Lerner commented on Mar 5

    Buying opportunity of a lifetime? I read one analyst’s comments that 6 months following a 3% one day correction the Dow is higher over 75% of the time. That is actually a true statement. But let’s look a little more closely at such a strategy utilizing the last 40 years of Dow price data.

    If you bought the Dow the day after a 3% correction and sold in 125 trading days later (or six months), such a strategy actually generated 5081 Dow points out of a possible 11000. This is not a bad strategy especially when you consider you were only in the market 22% of the time. On the surface you made almost 50% of buy and hold, but you were in the market only 22% of the time.

    What the analyst forgot to mention is the drawdown characteristics of such a strategy. There were 18 trades in the last 40 years from this strategy. 10 of these trades had individual draw downs that were greater than 9%. In other words, you bought Dow the day after a 3% down day, and then you had to lose at least 6% or more of your money before the market turned around.

    In my opinion the real question with any strategy isn’t how much money you make but how you make your money. Yes, this strategy makes money, but it does so in a way that I think would not be tolerated by most investors.

    So being down 3% in a day does not identify a market bottom. Continued losses are just as likely as continued gains.

  20. Mike O’Connor commented on Mar 6

    This reminds me of why I canceled my Barrons subscription. Abelson just talks about the drop in bullishness in the AAII survey, leaving us to wonder what the magnitude of the drop might actually mean (as though no analysis were possible).

    If you download the AAII data and analyze it using a scatter plot of the forward return ratio (over whatever interval you choose) versus the bull-to-bear ratio, as I did, you’ll find that the most-recent ratio is not really extreme and that as a contrarian sentiment indicator it is presently neutral to slightly bullish. On it’s own that would indeed suggest that the downtrend could bottom out quite a bit below today’s levels.

Read this next.

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