Market Action: Past, Present, Future

The great thing is to last and get your work done and see and hear and learn and understand; and write when there is something that you know; and not before; and not too damned much after.
-- Ernest Hemingway

The market's health the past 8 months reminds me that I should reiterate my investing methodology. First, though, a review of the markets...

Based on closing prices for Monday, 30 June, the S&P 500/SPX posted its worst first six month return since 2002, and its third worst first six-months (negative) rate of return since 1965, down 12.83%. Okay, the numbers reflect what has occurred, but how about going forward...? Market history shows that "... 5 of the 10 worst first-half returns were followed by 2nd half performances that landed them on the list of the 10 worst performers as well. When the S&P 500 was on the worst 1st half and worst 2nd half performance lists, the average performance in the 2nd half of the year was another 9.9% loss. Years of positive performance do exist; most notably during 1970 and 1982. (When the S&P posted gains of more than 25% during the 2nd half of the year to finish the year in positive territory.)" (© Dorsey Wright Analytics)

Compare and contrast the interpretation above with this notional sub-set, "In the second halves of all presidential election years over the past 110 years, the Dow has gained an average of 9.7%. In the second halves of all other years, in contrast, the Dow's second-half gain has been 2.7%, or barely more than a quarter as much." (© Mark Hulbert)

Throughout stock market history, there always have been prevailing concerns that worry most investors; concerns that, in turn, cause a massive shift to one or the other side of the ledger. While the then-prevalent concerns exacerbate a trend, they rarely cause a trend to occur -- unless the collective action by the preponderance of investors betrays an element of real, or perceived, exogenous risk. (Risk due to factors outside market dynamics.)

Whether investors buy or sell, they discount the future (albeit the consensual perception of that presumed future, which is why the market is so often wrong), so this moment, every moment -- right here, right now -- is the where and when and what and how that separates the true long term investor from the poseur. A concentration of focus on a diminishing spot (the asymptote I mentioned in a previous post) helps to end the extant trend sooner rather than later. Of course, a quicker ending worsens the ferocity of the trend; a melt-up or melt-down. Which is where the market finds itself today; no question the current market environment is ugly, likely to worsen before it improves.

     [Graphic courtesy of Investors Business Daily]

No analytical methodology brought to bear (sorry, could not resist!) upon the market is perfect; not fundamental analysis, not technical analysis. And while company fundamentals have an important impact on security prices, the market reacts to company fundamentals in different ways at different times. A stock's price reacts 80% of the time to market and sector-related catalysts, with corporate fundamentals and valuation metrics a distant third and fourth. Nonetheless chart action tells all. Chart action reveals the markets' changing dynamics on a real time basis; the collective consciousness of all investors across all time frames.

A reader writes,
"The issue seems to be uncertainty (fear) and how you deal with it in the context of the 'market'..."

During the periodic bouts of weakness in the general markets, I seek the markets' leaders -- which I do in all market environments. A leader is a company whose product or service is a leader in its industry, and whose stock is a leader in the market. Of course, even the leaders will be thrashed about but rarely trashed, and, as a class, they always will come out from hiding before the markets' sun shines again.

I consult market action, and, during periods of market weakness, seek positive divergences. And vice-versa: negative divergences during periods of market strength. My indicators help to guide my portfolios to the inherent opportunities within the market's stronger-acting groups and sectors. Right now, for example (and obviously), the financials sector of the S&P 500/SPX continues to weigh heavily on the overall index, which reality could change at any moment, so I monitor closely for portents of bullish change.

Speaking of positive divergences, a NB: Whereas the DOW Industrials, S&P 500, and NASDAQ Composite (almost) sell today at a lower low than their March 2008 low, Apple (AAPL) sells at a price substantially higher than its March 2008 low. Things (always) change, but this positive divergence showcases Apple's relative strength and status as a market leader. The ability to perceive long term investments is far easier than long term investing, for obvious reasons, but one is the doubt, uncertainty, and fear that preys on investors' long term intentions and certitude.

 

Remember the core objective: building wealth, not trading willy-nilly. You and I seek the best of the best of all available investment opportunities, the creme de la creme, and then (strive to) hold on. Sometimes errors occur, whether by analysis or application (even by me), but those positions are sold, and the cash becomes available for the presumptive new winner.

The markets remain shuttered Friday for the holiday, and do not re-open until Monday. Thank goodness for small favors! Use the holiday weekend to regain your sense of proportion, catch your breath, and, oh yeah, have fun.

This post will continue with Part 2.

Full Disclosure: Long Apple.

 

Comments

[Dan Walker]

Two fundamental premises reign supreme: 1) The market is never wrong. 2) The market discounts EVERYTHING. Re-read point one and two. At this point in time, the market is discounting Obama getting elected President. The market discounted Kerry getting elected until August of 2004 when it bottomed at around 8700 on the Dow. At that point, the participants had a better view that GW would prevail (and I will not delve into the relative merits of THAT argument under present circumstances). Political discussions aside, the potential taxes, regulation, and socialism of Democratic leadership is hardly a balm to soothe the nerves of edgy traders. I believe everyone who has ever been in a pit has heard 'lord don't let the government screw it up worse'.

Clinton brought in Rubin, who congealed the PPT and kept equities pointed up and bonds pointed down. But when Clinton was Governor, Little Rock had more bond traders than anywhere outside NY (sorry Boca) and Clinton was friends with the worst of them. The traders had already met him at Memphis in May and had some feel for the guy.

Obama will have to show up in lower Manhattan and convince the traders he has the vision or the instinct, or else McCain will have to convince the same crowd he will win before equities will turn around. The market may give you head fakes; just remember point 1 and 2. A two month equity rally does not mean we are around the bend.

[fatcat]

Dan,you are giving too much weight to the election.In normal times I would agree with you,but fundamentals are so screwed up now,it would not matter if a monkey was elected..

[carey_jim]

Dan, you said, "Two fundamental premises reign supreme: 1) The market is never wrong. 2) The market discounts EVERYTHING. Re-read point one and two."

Then you said "Obama will have to show up in lower Manhattan and convince the traders he has the vision or the instinct."

What's it going to be: Obama's ability to convince traders about something or the market which is never wrong?

Last time I looked, traders executed orders from "the market" which is the sum total of all the investors.

[jjason]

Dear Dan,

You give too much credibility to traders and the market. As Buffet has said...buy low sell high...and how does one do this in the short term when for every winner, short term, there is a loser.

Anyway, I learned nothing from this article or your response to it.

OBAMA 08