A modest 0.3% rally in the S&P500, but closing above 1450 again shows this market is not on the verge of breaking down and the bulls bucked the best the bears could throw at it last week. Markets crash dramatically and we’ve moved beyond that risk of imploding.
Stocks are still finding support at these levels in spite of the dramatic slide last week. Up to this point smart money has been buying weakness and selling strength. Selling/shorting weakness or buying strength has been a recipe for disaster. But that is the contrarian way, go against the crowd. But please note the important distinction, contrarian is going against the crowd, not the price. Short when everyone is confident and complacent, not simply when the price seems too high. Our current rally demonstrates this phenomenon where high prices have lead to even higher prices because most investors have been fearful of the market, not confident and complacent. Buy fear, sell complacency.
For all the fear and risk in the markets, the uptrend is holding its ground. The problem most bears are running into is all their reasons for a correction are widely talked about, and thus priced in the market. In most instances we can safely ignore what everyone is talking about. Only fear the risks everyone is ignoring.
For three years everyone has been talking about slow economic growth, unemployment, European contagion, money printing, and a slowing China. There is nothing new about any of these ideas and the financial press is simply recycling old headlines.
If we look back at the last major market crash in 2008, how many people knew what mortgage-backed securities, credit default swaps, and financial contagion were prior to the crash? Where were all the gurus and pundits talking about how dangerous the market was? We were in the middle of an election cycle and headlines focused on the two parties arguing about how bad or good the economy was. It wasn’t until after big banks started imploding that we finally realized the severity of the situation. That single reason is why 2012 will not turn out like 2008.
When amateur investors are talking about these risks fluently, we know we can safely ignore them. Supply and demand dynamics in the markets makes it so all the people fearing those events have already sold, meaning there is far less downside left in the markets. But on the flip side, the market tends to over-estimate the worst and in most instances the actual result is not nearly that bad. When events finally play out better than feared, the markets launch ahead with all that pent-up demand rushing back into the markets. Now this isn’t a race with a starter pistol and an official calling false starts, in this race we can jump out of the blocks early and get a head start. And in fact this is exactly what happens most of the time as the market rallies in anticipation of a resolution and if you wait for the actual news, you are too late.
Stay long, but keep looking for opportunities to lock in gains. Technically there is another 125 S&P points of upside before we run into the 2007 highs. I’m not sure we’ll make it all the way up there before running into an intermediate correction, but it is on the radar and not out of the realm of possibility. The market is holding up well and refusing to crack after last weeks test, so the high probability trade continues to be on the upside. There needs to be a bit more optimism and complacency in the markets before we see a more meaningful pullback. But that day is getting closer.
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.