Friday, September 3, 2010

Explode Higher or Implode Lower?

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Several weeks ago, I wrote a piece called Time to Cheer or Jeer? where I offered three different scenarios for the stock market as you can see below (as of August 19).

At that time, I opined that scenario “A” was my chosen path for a variety of reasons. Fast forward to today, as you can see below, and the stock market is in the exact same spot as it was on August 19. So far, scenario “B” seems to be winning out, even though junk bonds, the cousin of stocks, continue to rally strongly to new highs. This behavior would be very atypical, but impossible, of a market about to really collapse.
But over the past few weeks, investors have become even more pessimistic about the future prospects for the stock market, which is a contrary indicator. That means, the more pessimistic people get, the greater the likelihood for a rally. If that doesn’t make sense, think back to the dotcom days or housing bubble. Right at the peak, investors couldn’t buy tech stocks fast enough. Remember “eyeballs over earnings”? With housing, people were saying that real estate had reached some kind of permanent shield against decline since “there was only so much land” and Wall Street figured out a way to make it forever cost effective.

At the bottom of the stock market in March 2009, we saw negativity like we have never, ever seen in the modern investing generation, just as stocks were turning on a dime and rocketing higher. Today, I am seeing sentiment somewhere between neutral and the worst of all time, which is fairly negative in itself. Investors have been running as fast as they can away from stock mutual funds and into bond funds. This has and continues to accelerate over the past few years. I think the bond wave will end very badly at some point, now or in the future, and people will be left holding the bag with massive losses, but that’s a topic for a different day.

Looking at stock market sentiment, traders using the more active Rydex funds are exhibiting negative behavior. Popular sentiment surveys from AAII and Investors Intelligence are also showing individuals and newsletter writers high level of bearishness. Small time option traders, aka mom and pop, have committed most of their money lately anticipating a lower market. Add all these together and you have the masses being very negative on the stock market, something that’s rarely right over the long-term.

I can throw all kinds of technical measures, like the “washed out” nature of the advance/decline line, number of stocks making new highs and lows along with volume, but I think you get the picture. Those reading the Wall Street Journal or watching CNBC, FOX or Bloomberg probably have seen all kinds of scary warnings from the Hindenberg Omen, Death Cross, etc. There is PLENTY of negativity out there!

In short, stocks remain poised to rally and must do so almost immediately, scenario “A” above. Think of a rocket, filled with fuel, just ignited and trying to clear the tower. Unless it gains speed, takes off and explodes higher, it will fall back to the ground and implode. If the stock market cannot rally here (I think it will) with all the fuel loaded and ignited, I have grave concerns that at least a short-term collapse would ensue. And, of course, my chosen scenario would be wrong!

Feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC

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