Monday, January 30, 2012

"Debt is normal. Be weird." --Dave Ramsey

GLOBAL EQUITIES WILL CONTINUE TO RALLY, AND WILL THEREAFTER PLUMMET (January 30, 2012): The theme of the past half year among most amateur investors and hedge funds has been continued skepticism about the upside potential for risk assets including equities, high-yield corporate bonds, and commodities. Until recent weeks, there were consistent net outflows from equity mutual funds. In 2012, as they have continued to miss out on significant potential gains, some of these analysts and investors have recently turned bullish. However, a substantial percentage of financial advisors and analysts remain negative toward risk assets, refusing to recommend the purchase of stocks for various reasons. What is interesting is that many of them proclaim they are bearish "as long as the 2011 highs are not broken". Does this sound familiar?

On August 8-9, 2011, the S&P 500 slumped to its lowest point since the summer of 2010. Stocks spent weeks struggling to rebound, with many analysts stating that they remained bullish "as long as the market doesn't break below its August low." On the first trading day of the fourth quarter, October 3, 2011, the S&P 500 slid to a new bottom for the year. This caused almost the entire investing world to immediately turn negative, proclaiming that the market was completing a "death cross" which would lead to an additional 20% or even a 30% pullback. The stock market opened sharply lower on October 4--and then the S&P 500 gained 20% in less than a month. The early October decline was a head fake to encourage as many people as possible to sell when they should have been aggressively buying equities and high-yield corporate bonds.

Today, we have the precise mirror image of what we had experienced four months ago. The total speculative bet on a lower euro reached an all-time record during the past week. As the euro confounds this nearly unanimous bearish consensus by continuing to rally, stocks will continue to climb in tandem. As a result, it is certain that the S&P 500 will soon surpass its May 2, 2011 intraday zenith of 1370.58 to reach its highest point since the spring of 2008. This will force many bearish analysts to surrender and finally become buyers. As they act simultaneously, the S&P 500 will quickly approach and probably surpass 1400. Such a "golden cross" will appear to many technical analysts to be an upside breakout, but it will prove to be as false as the downside breakout had been in early October. While many will become buyers, it will present an ideal selling opportunity and will almost surely be followed by a bear market where the S&P 500 drops by at least 20%--and probably by more than 30% by the summer or autumn of 2012.

It may sound unusual or inconsistent to be strongly bullish in the short run and strongly bearish in the long run. However, a sharp February rally will induce people to buy high, while the subsequent multi-month retreat will cause them to eventually panic and sell low. Since this would result in the maximum number of investors losing money, it's almost surely what is actually going to happen.