Friday, May 08, 2009

On the edge and stumped

I've just returned from a three-week astronomy marathon in Texas. Maybe it's from a lack of sleep, but the stock market's behavior since I've been gone doesn't make any sense to me.

For starters, the S&P 500 index has just broken up through a rising tops trend line, without going through a significant correction first.

This doesn't happen very often. To add insult to injury, the accelerating rally is following earlier price formations that usually forecast price declines, such as the ascending wedge formation which formed last month.

My automated model which is based on historical trends is coming close to confirming an end to the bear market. In my gut I know this can't be the case, but I'm not about to toss away decades of stock market data based on a hunch. Since market sentiment remains very optimistic, my investment stance would change to neutral (cash/money market) rather than long (SPY, etc.)

For what it's worth, the stock market is highly over-valued, meaning that the current rally is mostly speculative and not based on any reasonable valuations. The projected real P/E ratio of the S&P 500 for the end of 2010 is now 26, and the dividend yield is still below 3%. However, as I've said before, earnings have very little effect on stock prices. The stock market goes up or down based mostly on whether investors have the desire to own stocks and the money to buy them. Apparently somebody out there has both!


Anonymous said...

Your sense of wonderment is in keeping with the academic literature i.e. technical analysis doesn't work.

You are on the mark. Stocks don't respond to earnings but rather psychology and the desire to own them.

Anonymous said...

It seems clear to me that reason is an impediment to profit-making in stock market investing.

I am curious, however, if you have the tools required and have done the analysis to answer this question: How many companies have had their common stock drop from the mid-double digits to the 1-3 dollar level, and recover again to anywhere near their original valuations? Citi and BAC come to mind...

Anonymous said...

You've pinpointed exactly why I quit trying to time the market short-term and instead use longer term EMAs, all of which are about to ttell me to buy.

Anonymous said...

Interesting times.

It seems many things are turned on their ear.

Your graph's question marks are rather apt.

Catherine W.

John from CO said...

I certainly agree with your comment that stocks respond to psychology...not earnings, however with a qualifier; in the shorter run. In the longer run, they do respond, in large part at least, to earnings and macroeconomic factors. What impacts the "desire to own" stocks? In the shorter run maybe momentum, the media, neighbors, fund managers, Jim Kramer, etc. But in the longer run what is it? Why are banking stocks a small fraction of their value of just a year ago or GM and Chryler almost at or at zero? Bankruptcy is based on a companies inability to earn real profits in the longer run with psychology playing some role (Bear Stearns and Lehman Brothers). Only the government saved AIG and Citigroup. They would have been worth zero or negative (credit default swap obligations), but not based on psychology. Real earnings and real value was the bottom line. So where is the market moving in the longer run? Hodar mentions actual earnings and dividends for a reason, or not? Maye the debate is "how do we define the shorter or longer run?". I'm definitely interested in comments from anyone.
John from Colorado

Anonymous said...

a bit of history:
The market's moves after the 1929 market crash, stocks plunged about 48 percent in just two months following the Oct. 29 crash, only to surge 48 percent in the next six months.

But the next two years saw a crushing drop in the Dow Jones industrial average-which at that time was trading off a Sept. 3, 1929 high of 381.17-that saw the index lose 86 percent from the high of the rally.

Maybe - just maybe - you are right on the mark. The market is bouncing up, but your data says it's over priced and should go down.

Whadda ya think?

Anonymous said...

If something has real value but folks are afraid to buy it, it's price drops so it's value become to some extent tangential. People that know it has value may or may not "get in early". There are a lot of times when money sits on the edge of the pool waiting for everyone else to take the first dip.

It seems to me that herding behavior has a lot more to do with stock price than value (or lack there of) does.

How many good companies have had their stock prices decimated because they were more liquid investments than, say, credit-default swaps?

Tim said...

John et al

I am not an professional investor by any definition but my observation is that stocks price in book value as much as the trajectories of growth & future earnings.

Exihibit A is Microsoft. It has never traded at its old peak of $50+ despite now paying a dividend and making even more money in real dollars. The reason. Growth slowed. Money found other more exciting places to be.

Banks, Retail, Tech, etc will probably not see their old highs for quite a while if ever.

Oleg said...

Jody, just curious if you are still holding GRZZX that you bought in March or planning to cash it out in the near future?


Jody Wilson said...

My Roth IRA is still 100% in GRZZX.