Trader’s Narrative

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Get a FREE Subscription to Futures Magazine (limited time for US residents only)
• Doug Kass Thinks “It’s Different This Time”
• How Did Economists Get It So Wrong?
• Contrarians see hope for gold breakthrough
• How the Natural Gas ETF (UNG) Distorts the Market
• More Questions Raised About Dow Theory
• The Earnings Season Debacle That Wasn’t
• Get the Elliott Wave Theorist for FREE (extended for just a few more days - get it NOW)
• Rating Agencies Must Defend AAA Junk in Court
• When to Exit a Trade

For the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back regularly since there are interesting links added throughout the week.

The Week Ahead

Bear market? credit crisis? It seems that both retail and institutional investors have for the most part either forgotten what happened just a few short months ago or convinced themselves that if everything isn’t fine, it will be (if they just wish hard enough).

For more economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all go to news.tradersnarrative.com:

• Cap-and-Trade’s Unlikely Critics: Its Creators
• Are We in a Bull Market Yet?
• RBS Strategist & Uber-Bear Issues Sell Alert
• Three Bad Reasons for Pursuing Trading as a Career
• Get a FREE Subscription to Futures Magazine
• The most accurate predictor of inflation
• Deflation Now Visible in China
• Soros: US Economy Has Bottomed
• Dow Theory Buy Signal
• The Dead Parrot of Finance
• Sun Tzu: Art of Trading
• Get the “Best of Trader’s Classroom” eBook for FREE (limited time)
• Your Brain Thinks Money Is A Drug

For the complete list, follow the graphic link below:

And remember to check back regularly since there are interesting links added throughout the week.

Week Ahead: Housing Data & Earnings

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Granville said it best in his book, A Strategy of Daily Stock Market Timing:

“When it’s obvious to the public, it’s obviously wrong.”

Since we talk a lot about sentiment and contrarian sentiment, lets step back and review where this idea came from and how it developed from its origins.

Charles H. Dow
The main principle behind contrarian analysis and sentiment (two sides of the same coin) comes from Charles H. Dow’s work on distribution and accumulation. The same ideas that underpin the Dow Theory. I’m sure you’ll also notice the similarity between these ideas and Weinstein’s stage analysis which breaks up a movement of a security into four parts.

According to Dow Theory, major market movements start with an “accumulation” phase where insiders, and other knowledgeable traders or investors start to buy shares. Since at this point the average public sentiment towards the market is negative, they are able to accumulate shares without significantly pushing prices higher.

Eventually the general sentiment starts to tip as more and more people start to realize that something has changed. This is the stage at which trend followers jump on and start to push up prices further. The trend continues and feeds on itself, perpetuating until it reaches a crescendo.
Continue reading ‘A Brief History Of Contrarian Analysis’

Far be it from me to criticize a luminary of technical analysis but it certainly appears that Richard Russell is confused.

For those who are unfamiliar with him, Richard Russell is known as the Sage of the Dow for his expertise in Dow Theory. He has been writing about the market non-stop for more than 50 years and has made some truly legendary calls.

In the past few years Russell was very bearish and recommended gold instead of equities. This changed in May 2007 when he surprised everyone by turning into a bull, saying, “an unprecedented world boom lies ahead”.

But recently Russell has changed his mind again, saying, “the long-term trendline has been violated… Until proven otherwise, the long-term trend of the Dow is now down.”

He was referring to the red support line in the chart below:

Russell drew the trend line from the low in 1982, the launchpad of the great bull market in modern history, to the low of the bear market in October 2002. Clearly, this support is now violated to the downside.

This sounds very logical but if you stay with me for a bit, I’ll explain why I have a tough time accepting it.

Let’s imagine that we have gone back in time to the desolate bear market of 2002. Prices are careening into an abyss, pessimism is so thick you can cut it with a broker’s statement.

Now, standing as we are back in 2002, we follow the same process that Russell did and draw a trend line showing the support level in the Dow Jones from the bottom of 1982, connecting it to the low in 1995 and the low created in the aftermath of the September 11th 2001 tragedy. The line would look something like the dashed purple one in the chart above.

Obviously, even if we imagine ourselves in October 2002, for the sake of this exercise, we had no way to know for sure that this was the bottom. So rather than use it as the point through which to draw the trend line, we would use the points mentioned above.

So the conclusion that we would then draw is that the long term chart of the market is broken and the trend of the Dow is down.

But that would be incorrect.

Because not only would the worst of the bear market already have been over, within a very short time a new bull market would be born.

So clearly, hunkering down into “bear market mode” at this point in time (mid to late 2002) would do us no good at all. In fact, the smartest thing would be the opposite, to have cast around for beaten down stocks to buy in anticipation of the termination of the brutal bear market that we had so far endured.

Richard Russell usually concentrates on the Dow Jones but here is the chart of the S&P 500 for good measure, showing the same thing:

In the end, I’m afraid this leaves us where we started: confused. But it is one thing to flop around randomly, switching sides as the wind blows, and quite another to confess in frank humility before the power of the market that one is confused.

In an attempt to thoroughly confuse my remaining few readers, here are two polar takes on the market:

Seasonality
The best time to be long the stock market has been from November to the end of April. The months from May to October, produce so little in returns - on average - that you would do better parking your money to earn income. This seasonal pattern is usually expressed with the rhyme: “Sell in May and go away”.

Now, this is just a historical pattern and it doesn’t perfectly play out each year. But over time this has been the average performance. So now we have seasonality working against us, rather than with us.

As well, Hulbert did a quick study showing that winter months that have produced negative returns go on to produce negative returns in the summer as well. But winter months that have produced positive returns buck the “sell in may” trend and continue the positive performance.

The only good news from the data mining is that the summer months following down winter months have much higher volatility. So for those who are equally comfortable going long and short, we may have perfect trading weather breaking on the horizon.

Oracle of Dow Theory
On the plus side, Richard Russell, is unapologetically super-bullish. Russell believes that the bull market never really left. Even the 2000-2002 bear market was just a “correction” within a continuing secular bull market that began in early 1980’s.

He bases this on two reasons: during the darkest days of the bear market in 2002, we never really got to a true bear market valuation. Two, from a technical point of view the market has been building a base.

Russell is worth listening to because he has seen decades of market history and he has studied it closely day after day. There was a time when he was a frequent writer for Barron’s. This was way back when Barron’s had a technical analysis bent, before it jumped the shark.