Is it really 2001 again?

I thought this would be a good time to revisit our 2001 vs 2008 Comparison of the S&P 500 from late April.

So far, the correlation is quite high both in timing and in respect to the technical indicators. We have seen the SPX fail at the 50% Retracement after only an intraday spike above the 200 day moving average. In 2001, the failure was short of the 200 day and never penetrated the 50% Retracement. Both failures occurred around May stock options expiration in late May.

The weekly 13/34 exponential moving average indicator (a favorite of John Murphy at Stockcharts.com) has recently confirmed its first sell signal since 2003. Additional similarities are present in the monthly indicators like MACD, RSI and ROC which are also all on sell signals for the first time since 2003.

Finally, the SPX has completed a test of the 80 week moving average from below as resistance. This is a critical level as described in The Significance of the 400 day (80 week) moving average. Just this past week the SPX also closed back below the 160 week moving average for the first time since early April. The last major break of the 160 week moving average before this, was of course early 2001.

Those who traded or had investments in the market in 2001 have vivid memories of what came next I am sure. The SPX dropped almost vertically from late May to late September shaving off 28% from top to bottom. The markets were closed for a full week during that time following the tragedy in New York. They opened in panicked fashion with many professionals talking of patriotically buying; yet most were selling with a fear they had never known in their lifetimes. The fear was so great that in just 5 days it was over. The SPX had dropped a staggering 150 points.

But then it bounced hard, rising over 24% by the first week of the new year and completely erasing the 150 point drop with a 232 point advance. That is a severe example of a fear based washout buying opportunity.

Which brings me back to today in 2008. I think we are on the verge of seeing a similar, if not as intense, buying opportunity within the next four months. Sometime between now and October, we will see another fear based washout. NOTE I AM NOT PREDICTING ANOTHER 9/11 STYLE ATTACK! In fact, this buy recommendation would be violated by such an event.

I am predicting that the fear level will rise to a point that just begs a contrarian investor to make a fortune. There will be no one left to sell and only a brave and brilliant few prepared to buy at super sale prices. This is when vast sums of wealth are transferred from the many to the few.

Knowing the exact timing and location of such an event is almost like predicting where lightning will strike. It can’t be done exactly ahead of time, but if you stand outside in an electrical storm with a giant metal rod in your hand, your odds go up tremendously for finding it.

I believe the storm is brewing and we could see this buying opportunity as early as this week. The level of fear present in the general press is notable and they are notably good at being wrong. The number of Bearish Investment Advisors as surveyed by Investors Intelligence has also recently eclipsed the number of Bulls, a rarity usually reserved for an upcoming washout. This is confirmed by AAII Sentiment Data showing Individual Investors firmly in the bearish camp as well.

All we need now is a trigger to send the masses running for the exits as they are already primed to do. This will most likely manifest itself with a climactic selloff accompanied by a surge in volatility and a spike in the put/call ratios. This will be our signal that the fear has peaked and we will strike like lightning, becoming some of the lucky few to benefit from the shortsightedness of the many.

A drop of merely 40-60 points on the SPX would be plenty and the faster the pace of the fall, the better. This scenario would see the March lows hold barely, after intense selling pressure that caused fear levels to spike. One could plausibly argue this would have occurred also in 2001 if not for the subsequent attack. We just need everyone who wants to sell, to go ahead and get it over with.

If you’re really greedy (or just that good) you could try shorting here and cover into the panic. For my money, I am thinning out the shorts and the bonds I added previously and I’m looking for a fire sale on the long side. Even if this doesn’t turn out to be THE BOTTOM, it will surely be A BOTTOM that offers plenty of profits.

We will look to book those profits, or initiate short positions, or both in the area of the aforementioned 80 week and 200 day moving averages. This will offer approximately a 10% profit window in the SPX; much more in market leading stocks & funds.

Make up a short list of buy candidates for the upcoming sale, I already have mine.

Updates:

Are We Scared Yet? June 30, 2008

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