Stock Market Bottom and the Bookstore Indicator

By: Clif_Droke

It’s hard to be positive about the stock market when all around us gloom prevails. Visiting a local Barnes & Noble recently made me conscious of just how gloomy everyone is feeling these days.

While there I made a list of some of the titles in the financial section. Finding a book these days with a bullish theme – or even a non-emotional, level-headed theme –is like trying to find a needle in a haystack. All I saw was one bearish tome after another. Here’s the list of titles I compiled:

Panic

Meltdown

Mr. Market Miscalculates

Financial Shock: A 360 Degree Look at the Subprime Market Implosion

Empire of Debt: the Rise of an Epic Financial Crisis

The New Economic Disorder

Plunder and Blunder

Bailout

The Origins of Financial Crises

The Gods that Failed: How Blind Faith in Markets Has Cost Us Our Future

The Coming Economic Collapse

The Coming Generational Storm

The Return of Depression Economics

Agenda for a New Economy: Why Wall Street Can’t Be Fixed and How to Replace It

Guide to the End of Wall Street As We Know It

It reminds me of the late ‘90s Dotcom Bubble when you couldn’t visit a bookstore without seeing one outrageously bullish title after another. Only this time it’s the exact opposite. I never thought I’d see this day come so quickly but it’s actually cool to be bearish…bearish is the new black. If you aren’t bearish, you aren’t “with it.”

Back in the late ‘90s, you were a true loner if you were bearish. Being bearish made you the butt of many jokes and an outcast in the financial community (I speak from experience!) In 1999 when the market was surging to new highs and everyone was feeling fat and happy, it was commonly voiced that there could never be another major stock market crash – there were simply too many “fail safes” built into the system…and the government simply wouldn’t let it happen. In the waning months of the great 1990s bull market, it felt like the market would never stop going up and you felt stupid for being a standalone bear in a sea of bulls. There were many times you felt like capitulating and jumping on the bull market bandwagon.

Yet patience paid off and like every other time in market history, the extreme manifestations of the prevailing trend meant a reversal was at hand. At that time the bullish theme was so dominant it was the subject of newspaper editorials and comics; talk show hosts and standup comedians made constant reference to it…everyone was talking about how wonderful it was to own those mutual funds and Internet stocks. In short, the bull market was in everyone’s lexicon.

Did the contrarian principle stop working back then? No, it still worked. It just took time for the extremity of the market’s upside momentum to dwindle and for the trend to finally reverse. The contrarian principle rarely delivers instant gratification, otherwise everyone would be savvy to it. In retrospect it’s easy to see how all the signs were in place for a major bull market top in the year 1999. But at that time it felt like an eternity before the market finally responded to all that excess bullish emotion by going in the opposite direction.

So here we are today, some 10 years later and we have arrived at the other extreme of the financial/emotional spectrum. Instead of pervasive optimism we have entrenched pessimism. Instead of the “buy, buy, buy” mentality we constantly hear “sell now!” “Cash is trash” was a commonly heard mantra in 1999. Today it’s “cash is king.” Sunshine and lollipops has been replaced by doom and gloom.

It’s all too simple to believe that “this time is different” because… But let’s not kid ourselves: it’s never different when it comes to the stock market. History always repeats in this business and this time around will be no different. The market is trying our patience and it may well string us along in our present nervous condition for a while longer but I have no doubt that our patience will once again pay off.

Returning to the aforementioned list of book titles, one of the themes that strikes me in this collection is the notion that somehow the market failed to protect us from the credit crisis. The book titles, “Mr. Market Miscalculates” and “The Gods that Failed: How Blind Faith in Markets Has Cost Us Our Future” speak to this end. One of the pillars of any form of market analysis – whether technical or fundamental – is that the market is a discounting mechanism and is always essentially correct. I don’t think this time was any different. The idea that the market “failed” is misguided and in many cases is a convenient excuse for those who were severely hurt by the credit crisis.

I would also be remiss if I didn’t point out that the last time the S&P was down by this much was at the end of the 1974 bear market. That particular bear market ended on October 8, 1974 with the Franklin National Bank collapse due to fraud and mismanagement. At the time it was the largest bank failure in U.S. history. It’s easy to point to the lingering weakness earlier this year following last year’s 6-year cycle bottom. Yet these obvious signs are always typical of major bear market lows and shouldn’t be used to extrapolate the downtrend or build a base for an even bigger crisis.

As discussed in our previous commentary, while the S&P 500 Index (SPX) did technically violate the November low last month, this doesn’t automatically pave the way for an implosion. The 1981-82 bear market ended with the SPX breaking below key support at the 107 level in August 1982 but this proved to be only a temporary “head fake” before the final low was in. This time around should end up with a similar ending.

Up until recently, a lack of follow-through has been the main problem plaguing this market since the New Year. Every time a rally has commenced the sellers have thrown cold water on it as institutions have used every micro-rally as an excuse to unwind their derivative positions. But we’re not seeing a distinct change in market attitude since the announcement earlier this month concerning China’s economic stimulus. The market has since then: 1.) rallied on good news on several occasions and 2.) refused to succumb to negative news on more than one occasion. From a basic tape reading standpoint this is exactly the way we want to see the market acting for the market to gain traction and push higher.

Even some high-profile super bears have been forced to recognize the pent-up energy and undervaluation of this market. One well known bear in particular recently covered a huge short position and it seems others have followed his lead. In a market that was previously dominated by negative sentiment and the short selling tended to add to the downside momentum, a lifting of short selling pressure is just what the doctor ordered for this market.

Another piece of good news that made the rounds earlier this week was the announcement by the SEC that it would consider reviving the uptick rule for selling stocks short. The uptick rule, adopted after the 1929 stock market crash, allowed short sales only when the last sale price was higher than the previous price. The Securities and Exchange Commission abolished the rule in 2007, after concluding that advances in trading strategies rendered it ineffective.

In fact, it was just after the SEC abolished the uptick rule that the bull market peaked and the new ruling allowed the free-swinging hedge funds to generate more downside momentum than they ever had on previous declines. This is not to say that the abolition of the uptick rule created the bear market, only that it fed the downside momentum once the bear market began. Since its abolishment in 2007, the lack of an uptick rule has only served to “grease the pole” on which stocks have slid lower ever since. And let’s not overlook the obvious parallels with changes to the uptick rule and previous stock market tops and bottoms: The 1934 adoption of this rule coincided with a major market low.

So there are some very positive developments taking place right now that point the way for the next interim turnaround to begin. Unlike the previous “false starts” after the 6-year cycle bottomed last fall, these aren’t merely technical or cyclical developments. These are psychologically-based and as we’ve argued in these reports, a major shift in investor psychology is the key factor in putting an end to the selling pressure. It now appears we’re finally seeing that longed-for shift in psychology.

By Clif Droke
www.clifdroke.com

Clif Droke is the editor of the daily Gold & Silver Stock Report. Published daily since 2002, the report provides forecasts and analysis of the leading gold, silver, uranium and energy stocks from a short-term technical standpoint. He is also the author of numerous books, including 'How to Read Chart Patterns for Greater Profits.' For more information visit www.clifdroke.com

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