Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Tag: Contrarian

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.

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 sp500 stock market reelected

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.

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.

bear bull trap stock market top

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.

sentiment chart rydex fundsrydex sentiment chart bearCharts from SentimenTrader.com/blog. If you are interested in contrarian analysis and market sentiment I highly recommend the subscriber service at SentimenTrader.com.

A Quick Look at the Stock Market

A quick look at a chart of the stock market movement since the October bottom. Annotations provided in the chart. Feel free to leave a comment!

stock market  contrarian rally

The Truth Behind the Trader on BBC

If you have not seen it yet, see the clip from BBC about the trader who spoke frankly about what he thought about the market. Some of the things he says is:

  • The smart money, do not buy the European rescue plan. The stock market is finished. The Euro is finished.
  • That he and most traders do not care about how the economy goes. He says that he goes to bed every night dreaming of a recession since they equal opportunities.
  • A trader or any person can make money if he is prepared.
  • This economic crises is like a cancer. It will just grow if not taken care of. Get prepared.
  • Governments don’t rule the world, Goldman Sachs does, and Goldman Sachs does not care about the European rescue package.
  • In less than 12 months the savings of million of people will vanish, and that is just the start.

[youtube_video=http://youtu.be/aC19fEqR5bA&rel=0&w=570 rel="nofollow"]

 

I mostly agree with him, and think he has some good observations. But there are two main issues here that I want to point out. Firstly, from a contrarian view it is very bullish when mainstream television like BBC air such an ultra negative outlook like this.

Secondly, what is really interesting is that many newspapers today write about this interview. But instead of focusing on what the trader said, they focus on him as a person trying to discredit him. When people trying to hide their heads in the sand by discrediting sources instead of statements, then that should be seen as very negative from a contrarian view.

Market sentiment remains very negative at the moment, making it hard to bet on a downward market (S&P500 1163), more upside risk than downside risk at the moment. However, the long-term outlook is still very bearish as long as most people are denying the risk of a disaster.

Gold Sentiment among Portfolio Analysts

In this short article I will follow up on the ways to look at gold sentiment to judge whether it is a good time to buy or sell gold (or sit on your hands). This time we see how portfolio analysts look at gold to see if they are too enthusiastic or too negative.

According to Hulbert at MarketWatch, “that huge two-day drop in late August did scare a lot of erstwhile bulls into becoming almost stubbornly bearish — which, from a contrarian point of view, is bullish. As a result, even though gold bullion is now back within shouting distance of its August highs, gold market sentiment remains remarkable subdued.”

They write that the average recommended gold market exposure among a subset of the shortest-term gold market timers currently stands at 40.3%. While it stood at a much higher 67% in late July.

So even though gold has climbed $300 and 18% since July portfolio managers are more negative (or less positive) now. Since the typical pattern is for gold timers to become more bullish as the market rises, and vice versa, this development is bullish from a contrarian point of view.

gold sentiment bullish chart

 

Negative Interest Rate in Swiss Franc… Again

Switzerland is now charging interest (or call it a tax if you want) if you want to lend the country your money! That is right, for every franc you want to lend them they will give you less back.

No matter how crazy this might sound, this is actually for the second time period in history that Switzerland charge investors to give them money. The first period where Switzerland had negative interest rate was in the 1970’s and that initially lead to a decline of 27% before the appreciation continued. Switzerland sure seem like a country who knows how to take care of its currency. Maybe something other countries could learn from.

Today you have to pay 0,82 Swiss Franc for a U.S. Dollar. The facts above indicates that the market sentiment is a bit stretched to say the least, and if the pattern from the 1970’s repeats, then there seem to be a good risk/reward to buy U.S Dollar with Swiss Franc. 0,7765 is where I put the stop loss for this idea, which is 5,3% below current value.

US Dollar Swiss Franc USD CHF

Beware! Be sure to understand money management and the risk of trading before attempting any trades. For instance, in the example above, if you only want to risk 1% of your trading capital you need to invest a fifth of your capital. There will be a risk and money management article coming up in later posts.

Bernanke Speaking at Jackson Hole

FED director Mr Bernanke is now starting his speech in the Jackson Hole FED-bank conference.

bernanke jackson hole stock market

The market participants are now waiting for news about the economy. Last year a big rally started in the stock market that lasted until this summer.

This time people do not seem that optimistic about the things Bernanke has left to offer. A Quantitative Easing number 3 is what many hopes for to help inject money into the markets. But even if that comes that is no guarantee for a raising stock market.

The positive side, I think, is that so many are negative now and not many believe in a strong stock market. That is the only, but very important, tell that we might enjoy some strength in the market.

But beware of volatility. Always take smaller trade sizes during times of high volatility. More about trade sizing in later posts.

S&P 500 is at this time down 1,3% to 1144.

POST-MEETING UPDATE 16:48 CET

No specific information about quantitative easing was given as most had expected.  But Bernanke said that the U.S. Federal Reserve will do what is necessary to support the economic recovery. — Suprise suprise!

The recovery in the U.S. economy remains modest. The recovery is slower than the Fed had hoped for, but the Fed continues to expect better growth in the second half of 2011. — I think you should change the world “expect” for “hope for”. What they or any expert expect is rarely what happens.

While noted a significant growth in the global economy and America’s banking sector is generally in much better shape now, says Bernanke, and I believe him, but it is not now I am worried about. It is tomorrow or next year. Warren Buffet also seems to believe in the American banking system. Google Buffet + BAC for more info about his latest investment.

The Federal Reserve has a number of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. — They might have the holy grail but they have not used it yet and do not want to tell us about it.

Their next meeting is in one month.

S&P 500 is at this time down 0,7% to 1152.

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