Trader’s Narrative

Here is a chart plotting every single major rally in the Dow Jones Industrial index since 1900:

Source: Chart of the Day

While the Dow has surpassed its highs from last month, this has not been confirmed by other major indexes. In any case, there have been 27 significant rallies in the past 109 years of market history - not counting the current one. That’s about one for every 4 years. Paul Desmond of Lowry Research pointed out this four year cycle as one of his reasons for believing this to be a real bull market.

About three quarters of the rallies resulted in a gain of 30%-150%, lasting 200-800 trading days (9.5 months to 3.2 years). These are the data points highlighted in the blue shaded box above. The current rally is just shy of making it as it is too short in duration.

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While we all like to think of ourselves as rational beings, making decisions based on sound judgment, the truth of the matter is much more unsettling. We are, for the most part, rather peculiar creatures, prone to irrational and emotional biases. What makes this even more disturbing is that the edifice of our economic and financial system is built on the foundation of a rational, utility maximizing individual.

The most recent sentiment overview shows an amazing turn of events. Even as the stock market has gone on to rise almost 60% from its dark depth 8 months ago, a moderate correction was enough to plunge the majority of retail investors into a new state of capitulation.

Even more curious, instead of investing more as the stock market recovered, which is the norm, the US retail investor has completely given up on equities. Here is an updated chart which I originally shared two months ago (Equity Mutual Fund Outflows):

If anything, the exodus of US retail investors (mutual fund owners) has intensified. The data for the full month of September shows redemptions of almost $13 billion - the most since February, just before the spring rally started. And to make it even more bizarre, the frenzy of bond buying is getting even more frenetic with net purchases of $55 billion (in September).

The data for the latest data (3 weeks in October shown in darker colors) promises a continuation of the same trend, if not a new record. So far, October had net equity redemptions of $11.5 billion.

Almost the same can be seen from insiders trading activity. These more ‘in the know’ individuals have continued to sell shares of their company’s stock almost as fast as they could. While there are many reasons for an insider to sell (diversification, divorce, etc.) the fact that we aren’t seeing an uptick in purchases is telling.

So why is there so much pessimism around this latest stock market rally?

Loss Aversion
A concept from behavioural finance offers a possible explanation for the bizarre fund flows pattern, bearish investor sentiment and insider selling. “Loss aversion” is a concept from prospect theory which explains that people prefer to avoid losing, rather than take a proportional risk to receive a gain.

Think of it this way. Given an event which triggers either a loss or a gain of the same amount, for some strange reason, we prefer to avoid a loss, rather than receive a gain. In other words, we prefer to keep what we have (not lose some or all of it), rather than add to what we already have. For most people, losing is much more painful than gaining is pleasurable.
Continue reading ‘What If Wall St. Threw A Party, And Nobody Came?’

Last week we reviewed the latest position of Lowry Research on the stock market: Turbulence Ahead, Uptrend Intact. One of the major reasons that Lowry’s continues to believe in the health of the market and a continuation of the uptrend is the lack of selling pressure.

Lowry measures this through their proprietary metric called (what else?) Selling Pressure. It remains low and falling, helping to support the thesis of a healthy market rally. According to Paul Desmond: “Every major market top in Lowry’s 76-year history has been preceded by a sustained rise in selling pressure. With selling pressure recording a new 12-month low within the past two weeks, no such rise is now evident.”

This has got to be frustrating for the bears. But it is also unbelievable to the large number of participants in the market who continue to look at the current price levels as a mirage. The US retail investor is not venturing out into equities, even after watching the stock market climb a wall of worry inch by inch.

This has been and continues to be the most hated stock market rally that I’ve ever witnessed. In any case, it is comforting to confirm Lowry’s proprietary measure of selling pressure with a similar measure from InvesTech.

Click chart to see larger version:

Source: InvesTech

Jim Stack, the writer of InvesTech has a handy checklist for new bull market conditions. One of them is this metric. And along with the rest of the list, it has been flashing a bright green buy signal for a few months.

As well, the month of November has been historically one of the best months for the S&P 500 since 1950. I’m not sure that another 20% rally by year end will convince the retail investors to risk their money in the stock market again. But we may just see that.

Since the start of the spring rally in March and into July, Lowry Research continued to recommend to its customers that the market would inevitably retest the lows and even see new ones. In June, Paul Desmond declared the impressive rally so far to be merely a bear market reaction and not a bull market. Then as early as mid-July Lowry was continuing to call for lower stock market prices (even lower than March 2009).

Lowry arrived at this conclusion by looking at their proprietary demand and supply metrics: Buying Power and Selling Pressure Index. And not through the by now well known Lowry 90%/90% metric. If you’ve been keeping track of these 90/90 extreme breadth days, defined by Lowry as a trading day where 90% of the volume flows to the stocks trading up/down and 90% of the securities traded finish higher/lower, then you know that what was once a rarefied event has suddenly become commonplace.

Whether the preponderance of extreme breadth days was because of the historic volatility we’ve seen recently or if perhaps it was due to the sudden spike in high frequency trading is of little importance. The only thing that matters is that as suddenly more and more people started learning about Paul Desmond’s research into the role of extreme breadth in creating the conditions for new bull markets, the game changed. And that is the inherent and tricky nature of the stock market of course. If you dare think you have it figured out, you are in for a big lesson.

In any case, now, Lowry Research, the oldest and most respected technical analysis firm on Wall Street, is reversing its position and issuing an intermediate trend buy signal.

To find out why they reversed and what the buy signal means, read on:

The signal occurred as of last Tuesday August 4th’s close. To trigger the intermediate buy signal, on that day, the Selling Pressure Index fell by 32 points from its most recent peak (on July 8th 2009 at 889). In simple terms this means that selling has exhausted itself and therefore, we now have a safer environment for an uptrend to establish itself. Starting in late July, Lowry noted that volume started to expand to the upside, something that was not happening in the early stages of the spring rally.
Continue reading ‘Lowry Research’s Intermediate Trend Buy Signal’

Today’s market strength isn’t surprising as we looked at different breadth measures that suggested that in the short term, the market was approaching oversold.

But today’s strength notwithstanding, looking out further along the time horizon, we are probably going to see lower prices. According to the latest report from Lowry Research, their proprietary Buying Power Index, which measures the demand side of the market, has falling dramatically.

Concomitantly, the Selling Pressure Index - their proprietary measure of supply - is now heading up after meandering for a few months. These two taken together mean that the stock market may even retest or go through the March lows.

The usual script for a new bull market is very shallow retracements and an immediate and aggressive bounce from any oversold condition. We are not really seeing that, at least so far - which leads many to conclude that we are not in a bull market but rather continue to trundle through a brutal bear market.

Although Lowry Research is probably best known for Paul Desmond’s seminal study of the role of 90-90 days in the birth of bull markets, they themselves follow their two proprietary supply and demand indicators for guidance on future market prices. To read more about Lowry’s methodology and charts of Buying Power and Selling Pressure indexes, see this: Lowry Research On Current Market Conditions.

You can also watch Paul Desmond’s recent CNBC interview where he mentions basically the same arguments for a defensive position going forward.