Key Reversal

Last night we had a Key Reversal in the both the S&P 500 and the NASDAQ. If one is to believe in classical technical analysis and its followers that is a sign of exhaustion and means that we should go further down. But be aware! According to quantifiable analysis of similar patterns we have NEVER seen a major top forming this way. Statistical analysis shows that we are going to have new highs and that will be the way we will primarily bet until new evidence emerge.

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S&P 500 Makes a New Multi-Year High

Some people cannot believe it — The S&P 500 and the NASDAQ 100 has made a new four-year high under what seems the be a financial Armageddon if one was to listen to the financial press. Readers here should not be surprised though. Let’s see what the last follow-up said and what to expect next.

From the last follow-up in the 23rd of April:

What can we expect next?

Most statistical signals are indicating that the market will be higher in the coming months. The risk-averse person should be out of the market while the speculative person should be buying on short-term oversold conditions and selling on overbought conditions.

What we should look for before expecting a longer change of the trend is that sentiment gets increasingly bullish while hitting new highs or that it gets stubbornly bullish while making the next correction down.

The market had a fair share of zig-zag movement and to buy the oversold conditions and sell on the overbought conditions would have been highly lucrative. So let’s make a new probability forecast:

What can we expect next?

We still have a few long and intermediate term indications of a higher market. We also just received some indications of some warning signs. According to the Hulbert Financial Digest, newsletters that are focused on the NASDAQ Composite index are now recommending a 60% net long position. It may not sound that extremely bullish but that’s in the top 11% of readings since 2000, and is up from a recommended net long of 18% just two weeks ago. Fundamentals can be regarded as either bearish (Q-ratio, P/E10) or bullish (P/E in a none recession environment) and that is why we don’t look at them to take decisions. At the moment we only go long on oversold conditions and sell on overbought conditions until a longer term scenario is set out by the market’s price action.

Good luck and please feel free to post questions or comments in the comment field of this post.

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Speculative Stocks

Most first-time investors and gamblers seem to focus on high beta stocks or markets, such as oil prospecting companies or the Russian stock market. In the article in the link below there is an explanation why there may be a negative downside to this besides just higher volatility.

[...] People who bet on horse races bet on the long-shot horses more than would be justified by the actual odds of winning (and conversely bet less than they should on the favorite horses). The story generally goes like this: Horse-racing bettors have difficulty evaluating small differences in outcome probabilities, for example the difference between a 1-in-50 odds horse and a 1-in-100 odds horse. That’s a 2% probability of winning versus a 1% probability of winning. This results in a large proportion of bettors placing too high of a bet on the longer odds because the potential winnings appear larger in that case.

The logic behind this behavior is most likely applicable to other markets of uncertainty such as the stock market.

http://isharesblog.com/blog/2012/06/05/a-lesson-in-minimum-volatility-gleaned-at-the-horse-races/

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Do You Understand Financial Markets?

Many think that they can easily understand human behavior and financial markets by reading financial press and use common sense. But when an outcome is based on complex factors such as human behavior, than outcomes can be counter-intuitive.

For instance, how would you like to bet on the Euro compared to the US Dollar? Most people would find that to be a really bad idea. However, we have had two years of horrendous news from Europe, and the Euro still gained (sic!) from $1,23 to $1,25 during this period. Who would have thought?

Another example of how complex human behavior is, or perhaps very simple and narrow-minded in some way, can be found in this graph from the betting firm Intrade. Below you can see the very close correlation between the S&P500 and how likely it is that Obama gets reelected. So it seems that reforms, tax-breaks, and competing candidates seems to matter very little compared to how the stock market performs.

obama Do You Understand Financial Markets?

Lesson to be learned, don’t think common sense as applicable to the financial markets, and with common sense I mean readily available information. The greatest brains in the world are setting the prices and they are not easily fooled. You rather have to think three steps ahead rather than one or two steps ahead.

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Cash Better than Stocks?

spider monkey 719 600x450 257x300 Cash Better than Stocks?In my search to provide you with more evidence that stock investments are bad placement for most investors/traders, I found an article about the e-book “Monkey With a Pin.” It’s free so go ahead and read it.

According to the book there is a 6% annual cost for the average stock investor trying to make money. Compare that to the long-term gains in the average stock market which is around 5 percent.

From the article about the book on the Sci-Fi blog:

Comley starts with the fairly undisputed fact that 85% of fund managers fail to beat the market each year.

Most stockmarket growth in the last century was generated not by capital returns – which were more or less flat, adjusted for inflation – but from reinvesting dividends.

Looking at the average investor’s return, which is biased by our overoptimistic need to buy high and sell low, Comley’s estimate comes in at between minus one or two percent.  That is, investor “skill” generally reduces returns by one or two percent. [...] Roughly fund investors appear to lose 2.2% a year, stock investors about 1.3% per year.  Those costs add up as well: they depend critically on your investment size, and the bid-offer spreads, but the Dalbar figure is roughly 3.8%.

The book also tried to give some answers to way people are so willing to keep investing in the stock market.

People do not want to put their capital in money market accounts since they are almost certain to give a negative yield when adjusted for inflation. However, as the article says:

Losing small amounts of money to inflation is far, far better than losing large amounts investing in overhyped stocks. The odds are against the investor, but loss aversion dictates that people will often prefer to take the gamble of a possible large loss, but a possible large gain, over a certain loss.

That is called the loss aversion bias, which is well documented in psychology.

Another fact is that people’s memories are anchored to the huge stock market gains of the 90′s and they still live on the hope to re-live that time once again.

Source: The Sci-Fi Blog

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Stock Market Analysis Follow-up

In my previous stock market analysis I thought the market would make a down turn before reaching multi-year highs and then make a false break up before a big downward trend.

What happened was, as you can see in the chart below, that the S&P500 index only made a minor move down (A), before it broke up (B) and giving a false buy signal so that people would buy, then continue down (C) tricking people it was a false buy signal so that they would sell. After shaking of some weak hands of their positions the years strongest rally started (D), which was followed by the years biggest correction (E) which again landed below the previous multi-year high.

The S&P 500 was trading at 1357 at the previous analysis, while todays futures indicate and opening at 1361 (+0,29% change) in over two months time. So although a lot has happened in volatility, nothing much has shifted when it comes to valuation.

So what can be learned from this? Well, we still see that the market trying to make the most amount of people to become losers. We also see that contrarian sentiment has been reliable. It showed us the bottoms at (C) and (E), when people quickly panicked and started talking about a bigger correction down. It also showed us that the tops at (B) and (D) were not likely to give stronger long-term trend changes since people had become skeptic about the market trend.

That is obviously the reason why the market did not continue down but instead made new multi-year highs.

ScreenClip 3 Stock Market Analysis Follow up

What can we expect next?

Most statistical signals are indicating that the market will be higher in the coming months. The risk-averse person should be out of the market while the speculative person should be buying on short-term oversold conditions and selling on overbought conditions.

What we should look for before expecting a longer change of the trend is that sentiment gets increasingly bullish while hitting new highs or that it gets stubbornly bullish while making the next correction down.

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Most People Should Rely on Passive Investment

The intelligence of the average stockholder is probably above the population average. Still they cannot bet the index. That is to say they cannot even beat random guessing, a coin flip, or similar, as the chart below shows.

Jemstep The Cost of Bad Buy Sell Investment Decisions 900 Most People Should Rely on Passive Investment

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Buffett Doesn’t Like Gold

Warren Buffett, the world’s most famous and richest investor, wrote the following in his annual letter to his stockholder:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce — gold’s price as I write this — its value would be about $9.6 trillion. Call this cube pile A.

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

Steve Beck’s has some interesting points in his answer to this in an article at Marketwatch.com.

“To explore this question, simply exchange gold for cash in this comparison. Would it be wise to own a huge $9.6 trillion pile of cash over $9.6 trillion in diversified corporate value? The answer is the same, no. The wise investor would select the diversification and compounding of corporate productivity every time. What can cash do for you other than sit there, produce nothing and deflate at an historic rate of approximately 3% a year.

Should you then draw a conclusion that cash does not belong in your portfolio? Obviously not. Even Buffett himself would acknowledge that cash, stocks and bonds are fundamental building blocks of a portfolio. Cash is useful on several levels including liquidity, security, fixed value, and simplicity, to name a few. Therefore, although you may not want your entire portfolio to consist of one asset class, you may in fact want some of that asset class represented in a globally diversified account.”

Read the whole story here: http://www.marketwatch.com/story/buffett-rebuffs-gold-but-inflation-says-buy-2012-02-29

Related articles:
Gold Weekly Buy Signal
Gold Sentiment Among Market Analysts
Platinum and Silver vs. Gold
Should I Buy gold?

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My Ideal Scenario

It is said be many, and I agree, that the stock market is rigged so that as many people as possible will be wrong as often as possible. This contrarian thinking is also backed by many studies which show that strategies that work are counter-intuitive.

So far it worked well for me trying to figure out the route of the market since I got active analyzing the market again last fall.

Let us take a look at my favorite scenario that I think will fool most people getting in the stock market at the worst time.

The facts are as follows:

  • Since last fall we have had many difficulties all over the world
  •  The stock market has risen a lot
  • Most people have been afraid of getting in the market
  • Most ways of measuring the trend is pointing up, which is what many people like to see before entering the market
  • The last movement up has been almost without any big draw-downs.

So most people now are noticing that the trend is up, they also read all the positive things happening in the economy (the bad things aren’t shown so much in media when the stock market is going up). So now people are looking at a time to enter the market. Every big draw-down now will likely attract a lot of money.

When the market finally enters a multi year high, just 2% up from where we are now, then they will throw their last dollars in desperation not trying to miss the rally. They do not even realize that they just missed a 25% move from the bottom. When that happens I think we reached a new multi-year high, maybe for many years to come.

This is just an ideal scenario that I would like to see. Of course there could be other similar scenarios or I could be totally wrong, but this would fit my expectation of the psychology and knowledge of the market.

Also note that I will short the market at a time when most of the traditional type of technical analysis would scream buy.

ScreenClip My Ideal Scenario

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Sentiment Getting Too Bullish

At this time I would recommend everyone to get out of all high risk assets such as stocks as we are reaching a multi-month high.

There are too many factors to mention but I will add two charts from the blog of SentimenTrader below.

What I would preferably see is that we get a new multi-year high which means above last summers high. We are very close to that now, only a few percent below. Then most people will reason that a new bull era has begun. That will be the mistake of the century. But at this time, at least get out of every high-risk asset and, and start taking small negative positions.

The market is now driven by enormous amounts of liquidity provided by central banks all over the world, and that is a strong force, but valuations driven by politicians rather than by value will be very vulnerable when reality takes its course.

20120208 rydex Sentiment Getting Too Bullish20120131 inversevolume Sentiment Getting Too BullishCharts from SentimenTrader.com/blog. If you are interested in contrarian analysis and market sentiment I highly recommend the subscriber service at SentimenTrader.com.

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