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A Defensive Posture Can Be Bullish


A defensive posture can be bullish from a contrarian perspective. But defensiveness en masse can be another thing, altogether.


S&Ps plunged 22 points during Friday's last hour. The afternoon's bounce had afforded market participants the luxury of fearing exposure to two days of illiquidity. Traders much preferred entering the weekend with positions that were either flat, short or crouching. In fact, S&Ps fell another seven points after the cash session close.

A defensive posture can be bullish from a contrarian perspective. But defensiveness en masse can be another thing, altogether. Some of the finer market bottoms are formed by scaring weak hands into distributing their shares into stronger hands. The bigger market crashes are triggered by distributing more shares than strong hands can absorb, and scaring strong hands into distributing, too.

That's right, I said it. Crash.

Such a big price drop doesn't make a crash any more or less likely. Crash events are an outlier, and never likely, they're only more or less possible. Last week's momentum is what makes a crash more or less possible. "Black Monday" (Oct 19, 1987) was preceded by a record-drop on Friday, following nearly two weeks of decline. But that downleg was actually the second from August 1987's top. The current pattern would equate more to Monday, Sep 8, 1987, where a 3-4 week bounce originated.

S&Ps still traded sharply lower that Monday, spending the entire session in negative territory, paring back early losses instead of extending lower. That's more likely than a crash, although a crash is still possible. Monday's least likely pattern is an immediate bounce, which would be denial, and any resulting gain would be fleeting.

The weekend's media didn't consider 1987's crash template nearly so much as this year's earlier correction. That story is much more bullish. The consolidation around February's new high was similar to this month's top (one-two days difference in length) and so was the reaction down (5.99% vs. 6.23% in as many days, so far). But similar setups that appear consecutively tend not to resolve similarly. So, while a bounce isn't impossible, a quick bottom like March's would be surprising, and a quick recovery like the one through last week would be a shock.

The weekend's media also fully vetted the sub-prime loan problems and their far reaching fallout. Most interesting was that the story's retelling could have been done by replaying show tapes from weeks earlier. Any new developments in the sub-prime story were already anticipated. It's difficult to believe that the fallout hasn't been largely discounted. To the extent this is true, the tail-end of last week's decline and any near-term lower lows are just a circular argument, the product of momentum from earlier selling.

To what extent this is not true, the media doesn't really seem to know. At least they have been focusing more on yesterday's news than on tomorrow's. Not that events will materialize that justify more selling (Iran?), but their potential can still influence selling decisions. Those unspoken concerns can become history by actually speaking of them, motivating the market to become even more defensive - and cheaper - but also hastening the decline's end.
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