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Eliminating the "Should Haves"

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Prepare for the market's next moves.

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Oscar Wilde said he could resist anything but temptation.

But doing something you know you shouldn't is easier if you can convince yourself that this will be the last time you indulge, that you won't do it again. So we convince ourselves that since we'll be strong in the future, we can still indulge today.

Whether it's smoking, eating too much, or going to the pub instead of the gym, we delude ourselves into thinking that we will take the more difficult path next time.

A few years ago, two economists actually looked at the issue using gym membership data. They found that in a club in which non-members could pay a no-strings fee of $10 per visit, people preferred to pay the $70 per month for unlimited access. And since members only attended 4.3 times a month on average, they ended up paying an average $17 per visit. The authors concluded this to be clear evidence of "overconfidence about future self control."

Investors understand the affliction all too well: A stock trades at $10 and we tell ourselves that we're buyers at $8. But how many of us buy when it gets to $8? Some of us do, but most of us don't. Most of us (I can't be the only one!) convince ourselves that it's going lower still: "I'll buy at $7" becomes "I'll buy at $6" and by the time it's back at $8 we're "waiting for a pullback."

Each investor has their own way of circumventing this problem. But at root, such poor decision-making is a consequence of our fundamental underestimation today of the discipline and even courage we will require in the future.

-- Dylan Grice, Société Générale


"I should have bought Walter Energy (WLT) at $67, North American Energy Partners (NOA) at $8, or (insert the stock of your choice) a week or so ago" was the cry on the Street of Dreams last week as the "selling stampede" seems to have bottomed in the typical 17- to 25-session time frame.

Indeed, the climatic action of February 4 and 5, whereby the Dow Jones Industrial Average lost 268 points on the 4th followed by another Dow Dive early the next day that reversed to upside leaving the senior index up 10 points, appears to have been the "low" we've been anticipating.

That sense was reinforced last Tuesday when the NYSE experienced a 90% Upside Day, meaning that more than 90% of the volume came on the upside with an attendant 170-point Dow Wow. It was the first 90% Upside Day since November 9, 2009, and was accompanied by a breadth reading of five advancing stocks for every one declining issue.

The result elicited a strong expansion in Lowry's "Buying Power Index" (read: demand) with an even more pronounced contraction in its "Selling Pressure Indicator" (read: supply). Moreover, the DJIA has now strung together more than three consecutive sessions on the upside, which also suggests that the "selling stampede" is over. Recall that stampedes tend to last 17 to 25 sessions, with only one- to three-session counter-trend attempts before exhausting themselves, and Tuesday was session 19 in the downside skein. Accordingly, the four-day positive "pop" should be viewed as a reversal of the nearly four-week "wilt."

Setting the stage for the stock market's reversal has been relatively constructive economic data implying that the first revisions of the fourth quarter of 2009 GDP (due February 26) are unlikely to be major, a Greek Gotcha that appears to be on simmer, a Chinese New Year that has closed their financial markets, also putting on simmer near-term worries of further monetary tightening, and a host of other Street-friendly figures.

Meanwhile, momentum traders, speculators, and model-driven players have been buying US dollars, which suggests another change in the trend since stocks rallied right in the face of a stronger dollar. Even more surprising was crude oil's spurt, as well as gold's weekly climb, given the "buck's bounce." Indeed, counterintuitive as it seems given the greenback's strength, the strongest sector last week was Basic Materials, which gained an eye-popping 5.02%.

Also of interest, at least to my firm because it's "long," is that Japan's economy expanded at a faster-than-expected 1.1% in the fourth quarter of 2009. Despite all of the negative nabobs, we continue to like Japan for a multiplicity of reasons. Apparently, so does Byron Wien, vice chairman of Blackrock Advisory Services and former chief market strategist of Pequot Capital and Morgan Stanley. According to Byron, "Japanese stocks will be the best investment among the world's biggest markets." He goes on to note, "Everybody who could sell Japan has sold Japan. Everyone is on one side of the boat. My view is that we have a pretty good chance of having this one be the best of the major industrial markets. It's not a boom, but things are getting better."

Obviously we agree and have been recommending tranching into the Japan Equity Fund (JEQ) and Japan Smaller Capitalization Fund (JOF).

As the savvy folks at the GaveKal organization opine, if China can change its business model from one of "labor productivity" to one of "capital productivity" (to gain more efficiencies on capital), it is hugely bullish for Japan because Japan does more business with China than it does with the United States.

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No positions in stocks mentioned.
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