May 29th, 2009

From Shoulder to Bump, Hopefully

Ever since the Crash began early last year, most investors have struggled with not having been adequate warned, not knowing what they needed to do, deciding when they should reenter the market if they were fortunate enough to have sought protection in cash. During it all, they should have been gauging their own psyches and the emotions of the market.

First there was disbelief, then fear in acting, then depression … well the following chart appearing in “Emotional Risk Management: Reflections of a Wanna-be Surfer” by Dr. Ken Celiano with Mark Paulik in the current issue of Stocks, Futures and Options Magazine tells the story better than I can:

The wave cycle (hence the title “Surfer”, I suppose) is a close relative and slightly different cut of the Market Life Cycle chart I’ve shown here before.

Where on this wave curve do you think the market is now? I look at all the emotional stages and believe we’re moving from Hope (third from right end) to Relief, equivalent to the transition from Accumulation to Mark-up on the Life Cycle chart. I don’t know about you but I can still remember when we moved from Euphoria to Anxiety during July-October, 2007, the periods of Fear, Desperation and Panic during the Summer and Fall of 2008 to finally Depression and Despondency between last October and this March. And since March we’ve been through Hope and Relief.

Throughout, I’ve tried to explain that the MTI (or the simpler and more conventional 200-day moving average rule) is less a prediction tool than it is a barometer measuring market momentum (i.e., emotions) plus a regulator of investor emotions. It told me that a serious decline was in the offing in February, 2007. While everyone was calling a turn last May, it pointed to a Suckers’ Rally. It allowed me to wade into the water beginning March 9 but to do so cautiously.

But we’re on the verge of stepping over important lines, of crossing from Relief to true Optimism, from Accumulation to Mark-up Phases, from under the Neckline and the 200-day Moving Average to above. Next week, we’ll probably hear the “all-clear signal” we’ll see the green light flashing. We’ll be able, finally with some certainty, to see upside momentum become self-sustaining and, consequently, to become fully invested in the market. For the first time since January, 2008, it could be relatively safe to be fully invested.

Astute readers will probably ask how I can write so positively when only last week, in “Is it déjà vu or something new” [what I meant the title to be], while describing an inverse head-and-shoulder pattern, I wrote:

we’re in the earliest stage of this bottoming process. In all likelihood, there will be a retest of the November low and it may or may not hold. What can be said, however, with some confidence is that the Index will not rocket through the remaining moving average benchmark hurdles without some retracements and retesting. As Cater Worth said this evening on CNBC, this bottom will be similar to the saucer bottoms of 2003 and 1974, not the V-shaped bottom of 1987.

Carter and I may have been wrong….to a degree. We may have missed the strength of the market and believed there would be a retesting, a right-shoulder to that pattern. But there’s a smell of optimism in the air and that shoulder may turn out to be no bigger than a bump. At least the strategy I spelled out in that post was spot on this week and made a lot of money for those who followed it.

Today’s 1.5% run up in the last hour must have been related to end-of-month trading (i.e, the desire to end with as good as possible month-end statements), so it can’t be extrapolated into next week. But, nevertheless, the focus of the discussion is about to change from whether and when we’ll cross the 180-day moving average (see January 5, “March to the 180-day Moving Average: Slowly“for an earlier reference) to whether the market will have sufficient momentum to cross of the 300-day moving average at 1050 and what might happen afterward.

Two moving averages have already turned up and, if the Index crosses the 180-day, it will begin working on turning the 180-day MA up, too. Rather than writing about a “base-building process”, you’ll be able to read about the Excitement, Thrill and Euphoria of stock picking in the Mark-up phase. I just can’t wait.

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