July 30th, 2009

The (Opportunity) Cost of Discipline

Some of you have written asking whether the MTI had yet given an “all-clear signal and I answered saying that it had – on June 1, over two months ago – but I held off committing until I saw confirmation that the inverted head-and-shoulder reversal pattern was successfully completed.

On July 23, when the Index burst above the neckline with a 2.33% move on higher volume, I continued playing it safe (i.e., overly conservative), waiting until it moved above the 300-day moving average which coincidentally meant also crossing above another significant resistance trendline. I thought that would represent the beginning of that “traders’ remorse” correction extending to the end of summer.

A few weeks ago in “Half-Full or Half-Empty Views: A Head and Shoulder Market Top?” of June 30, an extremely popular post where I compared what many saw as a top vs. my inverted head and shoulder bottom, I wrote:

“There’s no clear-cut requirement is for a right shoulder. The preference, of course, is to have it match in time and scale the left shoulder. But (and this is what it now looks to me like) it can turn out to be shorter and shallower due to the strength of the market driven by the sidelines money waiting to be invested.”

Even back to March 19, in a post called “The Debate is Settled: The Market Has Hit Bottom“, I wrote:

“The raging debate is whether the market has hit bottom. My unconditional answer is “yes”….I’m not clairvoyant but the “market” is….Market prices have taken all these risks into consideration today or, more correctly, the millions of investors, large and small, have factored these and many more issues I haven’t even thought of into consideration and determined that stock prices will more likely move up rather than down in the near term…..I’m having a really hard time sticking with my discipline, though, and resisting the urge to jump into each of the stocks that triggered alerts today. Even though we’re approaching the end of those 6 months and many stocks are now beginning to break to the upside, I’m still cautious because it could still blow up. It’s painful to sit watch these “opportunities” pass you by while you’re sitting on a large chunk of idle cash but the prudent thing to do until the market tells us otherwise. We’ll have a second opportunity soon…..Nothing moves in a straight line. After their initial breakouts, there’s a high probability these stocks will temporarily stall out (it’s called “traders remorse”) and return to test as support the trendlines that are now resistance. And when the test is successful and the upward trend is confirmed, that’s when we’ll jump with everything we have.”

Here we are four and a half months later, 25% higher on the Index and with 30% of all stocks having more than doubled from those extremely low, distressed prices. And we (at least I have) have been sitting on our hands waiting for that retracement. It just hasn’t come and perhaps won’t until much of that sideline money has been put to work.

It now looks like as if that sidelines money is being plowed into all variety of stocks without waiting for summer vacations to end. Tomorrow, the end of July, may see the Index cross above the 300-day moving average and nudge up against that long-term resistance trendline. And if it does so, I will have no choice next week but to ring the bell, blow the whistle, let the light turn from yellow to green and declare that there is little immediate term risk of a retest, a collapse back recent lows. The bull market will have officially begun. Optimism will again break out all over this land (click here to see chart again).

I’ve been identifying stocks that looked to be leaders in this market (“golden cross”, new highs, leading industries, foreign). Tomorrow, I’ll revisit a group that a while back I wrote would be a great barometer indicating whether this market was truly ready to take off: the Financials Sector, especially Money Center Banks.

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  • Z

    Thanks for your blog & responses!
    I had a few questions maybe you can address:

    What is your take on the amount of funds parked in money market accounts.. since you were making the comparison to 2002/03 it seems there is a big similarity here.

    What do you make of the wildly divergent opinions out there? There seems to be a lot of bears that are willing to bet against this break of a neckline of a possible inverted h&s. Seems like a poor risk/reward bet but maybe this is how you get a pullback to buy the remainder of your position?

    Cheers, Z

  • Guru

    Z, wish I had comparable statistics on sidelines cash for 2002/03 and today but don't. Do you have a source?

    As far as the Bears are concerned, they are basically fundamentalists and look at historical economic stats rather than investor sentiment (I would know, I'm married to one of those Momma Bears). They may be correct over the long-run but the short-term (to next May and 1200-1250 on SPX) looks more and more bullish.

  • Fresco

    Guru,

    Everyone seems to be drawing comparisons between the 1938 rally and this one. Any thoughts?

    Fresco

  • Z

    Hi Guru,
    I had found these articles related to cash levels and funds in money market accounts a while ago. I think it's very important in light of what happened in 2003:

    http://www.istockanalyst.com/article/viewarticle/articleid/3317524

    https://news.fidelity.com/news/article.jhtml?guid=/FidelityNewsPage/pages/mare-cash-on-sidelines&topic=investing-stocks

    Today I was reading Barron's and found the article below. While I'm weary about "cash on the side lines" talk often used by cheerleaders I think there is something here. (see 3rd last paragraph)

    http://online.barrons.com/article/SB124908134272998077.html

    I would like to see more information. If anyone has an info related to "normal" levels I would be appreciative.

    Z

  • Guru

    Thanks, Z, great references. If you don't mind I'll reference them tomorrow.

  • Z

    Sure, I don't mind Guru.
    I was looking around for absolute levels of cash and money market holdings as well as % of cash holdings of equity mutual funds.

    The charts stuck out to me b/c of the parallels between the current rally and that starting in '02.

    The other big picture question I had was about savings rates it's effect on markets. US rates have gone from slightly negative to 6%. Obviously if people save rather than consume the economy slows but those savings have to go somewhere and 6% is huge. If a portion of that aggregate savings goes into the markets what kind of impact will it have?