May 7th, 2010

Diversification is a placebo

I know it’s probably nothing more than a coincidence or randomness but yesterday’s incredibly volatile whipsaw market at its low point touched a trendline I’ve had on my long-term charts for some time.

Don’t believe me? Let’s rewind the tape and check out this post from August 30, 2009 entitled “Comparing Labor Days in 2003 and 2009“:

And if it does [“have a clear shot at a 10% surge to 1125-1150 by year-end”, a reference from earlier in that blog], what might come next. What might 2010 look like? Let’s look at the Tech Bubble Crash recovery, 2003-04, for an answer to that question:

The market came out of the Tech Bubble double-bottom with a 26% move in 2003, across the neckline in June 2003 and directly into a 3-month Traders’ Remorse Correction. That’s the sort of correction everyone looked for but never materialized this past summer. After traders overcame their remorse, the surge began around Labor Day 2003 and carried the market ahead 16% to mid-February 2004 when it entered a long, excruciatingly boring nine-month consolidation with no more than 7.5% range from peak to trough.

Now lets roll forward and see what the S&P 500 Index has looked like since:

We find ourselves this morning in the middle of what might turn out to be not the “beginning of the end” but what be the 2010 version of that 2004 consolidation. As volatile and violent as it feels going through it and with an equally unsettling economic and political domestic and international scene for background, this could all just be the 2010 incarnation of the long-awaited correction.

Over the next several weeks and months, the market could retrace the path of the structural glitch allowing yesterday’s 30-minute, 600-point, v-shaped panic but it also could lay a very solid foundation for the next push up to much higher ground after the summer as we enter the mid-term election cycle (see “Mid-term Elections in 2010 and the Stock Market” of January 28).

It’s at times like these that underscores that “diversification” is nothing more than a placebo for an ailing portfolio and market. The best way to win at times like these is to avoid risk, step aside, sell and build up a cash reserve for whenever and wherever the market finally settles down.

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  • Anonymous

    Hi Guru;

    Whats your take on gold and gold stocks going forward? (you knew someone was gonna ask !! )

  • Anonymous

    diversification is overrated, Bill Gate only own one stock MSFT!!

  • Joe

    Precious metals – the only thing I'm buying at the moment (DGP and SLV).

  • Anonymous

    Guru,

    Of all the sites that I visit, this is the best. Calm and pieceful even at the time of scary moments like yesterday.

    I have just one question. How far do you think this correction will go down in spx. Are we there yet or more
    gut wrenching selloffs. Talking heads and bear blogs are in full celebration. Also do you think we are going to see black monday this coming monday.

    Take a look at vix, fear index up 80% in 3 days.

    Thanks.

  • PTInvest

    Wondering what your take is on the whole lunar cycle thing that you've written about: do you think that last week's action kills that theory or is this just an a aberration? Thanks.

  • Joe

    Sure looks like the theory was eclipsed this week (pun intended). This phase doesn't formally end until for a week on May 14 but a recovery to 1191 looks pretty much out of the question.

    Having said this, I would point to the June 22 phase of a 4.22% contra-phase move; it was a big bomb but launched a nice string of hits.