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"It Wasn't Me"



Have you wondered whether you were buying the high tick in the market at any time over the past few weeks? It is a natural thought given the seemingly historic gains over the past six months. Just since the March low, the NASDAQ Composite (NAZ), S&P 500 (SPX) and Dow Jones Industrials (DJIA) are up 46%, 27% and 26%, respectively. How could anyone be positive after this kind of strength, during the evil September and October period, and with such positive sentiment? I guess that would be us!

Too Far Too Fast? Not according to the data since 1980. We wanted to look at the momentum in the market in the context of more than the bubble building and popping time frame. As we outlined in our "Upside Ahead?" piece in July, it is historically rare to have this kind of momentum using the monthly data after putting in a climatic low and reversal as the market did in March. The best way to show you this is you this. Simply put, an overbought condition in the monthly charts after a significant and climatic low, has been a sign of more gains ahead.

Exhibit 1 - Monthly Chart of SPX With 14-period Stochastic

Exhibit 2 - Monthly Chart of DJIA With 14-period Stochastic

Exhibit 3 - Monthly Chart of NAZ With 14-period Stochastic

Source of Monthly Data: Reuters

Bad Seasonal Period? By now, you have heard (just once or twice) that September and October are the worst performing months for stocks. Typically, stocks perform poorly during this period because corporate leaders and investors realize their expectation for year-end earnings results have been just a tad optimistic. They both begin to lower views, which ultimately puts pressure on stocks. That isn't the case as we exit the third quarter this year (Exhibit 4).

Exhibit 4 - SPX Ests. haven't ramped so they have less room to fall - especially given the current economy

Source: Baseline

Over the past couple years, there has been an expectation of a second half recovery that has not materialized. The failure, and therefore disappointment, created a healthy dose of skepticism that this year would be any different. The last thing CEOs and sell-side research analysts want to do is again be blamed for another case of high expectations and low results. We believe the historic bear market coupled with Regulation FD, has made those who dispense information very defensive and hesitant to raise guidance unless they truly believe they can meet or beat numbers. Healthy skepticism after prior second half failures and the hesitant nature of corporate leaders and analysts to raise guidance, may diminish the negative seasonal effect.

Sentiment Too Positive? As we travel around and talk to investors, we are constantly asked, "What do you make of the positive sentiment readings?" What a great question. Readings from the likes of Investor's Intelligence Inc., and the American Association of Individual Investors have suggested too much enthusiasm regarding the outlook for stocks. While that may be true, in our view, it is important to put the favorable sentiment into the proper context using examples instead of instinct.

A couple weeks ago, Barrons led with an article referencing the views of ten of Wall Street's greatest strategic minds. Ten out of ten were looking for higher stock prices ahead. That certainly smells of rampant optimism if 100% of those interviewed liked stocks - but was it really extreme optimism? Not when they were suggesting the best case would be 5-10% returns from current levels. Rampant optimism that generally accompanies a significant market turn and contrary signal would be statements such as; "stocks could return 20% per year as far as the eye can see because of the extraordinary economic growth and a new paradigm." Clearly, sentiment is not negative and we don't want to suggest it is. We instead believe the current psychology is that of skepticism. In the Cycle of Psychology (Exhibit 5) sentiment seems to still be in the "awakening" vs. "belief" stage. In this stage, sentiment is always positive, but people want to buy at better prices denoting skepticism.

Exhibit 5 - Still Awakening in Cycle of Psychology

Courtesy: Harvey Eisen of Bedford Oak

Straight Up? The equity markets have put in extraordinary gains since the low in March. Conventional wisdom suggests an overbought and extended condition could produce poor or sub-par results going forward. We simply want to put into context what generally happens after significant gains off a climactic turn (panic selling followed quickly by panic buying). We are sure there will be times over coming months where it looks like a meaningful decline is upon us - and indeed there may be depending on what one considers meaningful.

Just over a week ago, we too were looking for a 4-7% correction given some extreme near-term readings like the percentage of stocks in the S&P 100 (OEX) and NASDAQ 100 (NDX) that were overbought using a daily chart with a 14-period stochastic. Six sessions ago, the overbought reading for both was in the mid-70% range. As of Friday's close, that reading has dropped to 35% and 30% for the OEX and NDX, respectively. In English, the market is again working off extreme readings by churning vs. dropping. That is healthy, and for now it seems like worrying about being the last buyer is a bit premature.

I, Tony Dwyer certify that the views expressed in the research report(s) accurately reflect my personal views about the subject security(s). Further I certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report(s).

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