Articles from Oct 2008

Bullish Bias

There is panic in the air and people are scared. At this stage one should look at things logically and with cool head.
If you were following Market Monitor kind of market timing model, you were anyway out of market during the drop. So you have now luxury to play it cool. Think through your options and the opportunity ahead.
What does MM going green on primary indicator tell you:
When the number of stocks up 25% or more goes below 200, it indicates an extreme oversold level and is a bullish signal. Rallies that start from such extreme levels tend to be very powerful.

So we are currently at a stage which you will seldom see every year. It is extremely rare phenomenon. It tells you there is extremely high probability of a rally and any such rally will be very powerful.

My interpretation of that signal is :

We have high probability of a 20% or more rally starting in October lasting up to January in USA market and a rally of 30 to 40% in the emerging markets.

Does it mean it will start today, no. But we are in a zone from where a rally will start in next couple of days or weeks. Any rally of 20% and lasting 2-3 month will have lot of EP opportunity. As of now there are only 16 stocks up 100% in a year (DT) if you take out ETF. That number will expand to 300 plus in a 20% plus rally.

The most important thing required at this stage is cool mind and optimism.

A bearish bubble is developing

Alcoa is first large company traditionally to announce its earnings. Its earnings will be out on 7 th October. That will be the official start to the earnings season. Once the earning season starts the market will be focused on it.

 

In spite of the overall bearishness there will be companies which will do exceedingly well and market would still focus on them. Also investors would be keen on hearing about future earnings expectations of management. Typically market looks 2-3 quarters ahead and as a result the bad things are already priced in at this level. 

 

One of the temptation currently for most investor is to start believing in all the bearish propaganda. I will take a bet that 80% of the worst thing being predicted by the bears will not come true. You can go back and see history, you will always see that during panics and crisis , mass media and few pundits compete to create scary scenarios. Most of them never come true. 

 

 

By becoming excessively pessimistic you will have cognitive dissonance when market starts rallying. The biggest problem to watch for in analyst or in investors  is what psychologist call Cognitive Dissonance. Cognitive Dissonance is a phenomenon in which an individual or a group of individual with an established opinion refuse to accept another point of view, in spite of new irrefutable evidence suggesting quiet another conclusion.

Cognitive dissonance, refers to our desire to avoid believing two conflicting things. Whereby the brain attempts to find support for the belief that carries the greater attachment or emotional involvement by finding a way to ignore or discount the conflicting belief.

In the classic study of this characteristic, researchers found that once a person had purchased a particular automobile, they would avoid advertisements for competing models and seek out those for the model purchased, so as to avoid the pain of regret that was bound to follow if they were to realize they had made the wrong decision. One way to avoid regretting the purchase decision is to (irrationally) filter the information received (or believed) after the decision has been made. Similarly, people tend to minimize the importance of subsequent information that might call their original decision into question.

The upshot is that we resort to various subconscious mechanisms to defend our existing beliefs, even where the desire to maintain these beliefs has a less-than-rational basis.

Knowing this, how do investors adjust their behaviour to compensate for the tendency to avoid or deny new, conflicting information? The answer is to seek out contrary opinions; to realize that research doesn't stop once a decision is made; to strive to identify mistakes as early as possible and take pride in the ability to do so.
 

 

 

Historically periods of panics and bearishness have been brief. Government, regulators, entrepreneurs, investors, consumers all react to panic and make several adjustment to their behavior and choices. That does not get reflected in most current extreme bearish scenario.

As a  investors/ traders you need a  psychological make up to avoid such cults and be ready for a possibility of bullish scenario.

Archives

Tags

Categories