PSYCHED OUT: 
THE MEDIA AND MARKET BOTTOMS
by Clif Droke
August 13, 2007

I received quite a few e-mails last week asking if I had changed my bullish market stance based on the price action of the past few days.  My response is “why”?  The bottoming activity of the last several days is almost identical to that of the bottom following the late February panic sell-off and that one ended with the S&P 500 going on to retrace its losses and then making a higher high.  It took a few weeks to accomplish this but the end result was rewarding to those of us who never wavered and refused to turn bearish when the media were telling us the sky was falling and that a major crash was right around the corner.  This time should be no different.

Here we are in the dog days of summer in a much similar situation to where we were in early March.  The media are once again beating the drums of a coming crash and major bear market and once again the subprime crisis is being heralded as the reason for expecting the stock market to substantially weaken.  Smart investors don’t make their decisions based on headline news, otherwise they’d be the poorer for it.  Market psychology is the best judge of conditions and the likely stock market outlook, not headlines.  So let’s just look at what the market’s psychology indicators have been saying lately.

Despite the re-test of the August price low in the S&P 500 last week, the market’s main breadth indicators have already shown us that the internal low is already in.  The rate of change of price, volume and breadth have all been diverging higher in the past few days as the major indices made their way to lower lows.  This positive divergence of the market’s internals tells us that the decline has gotten out of hand and a reversal is expected after the current bottoming process is complete.  The past week was a big step in the right direction as the air has been clearing from the latest short-term cycle bottom.  

Since the latest market correction we’ve also seen the ARMS Index hit those super low levels commensurate with major market bottoms.  Even the 10-day moving average of the ARMS reading is sending a bullish signal on the stock market for the near term.  There have been two times in the past year that the ARMS Index 10-day MA has sent a strong buy signal.  In both cases (June 2006 and March 2007) the market reversed its decline shortly thereafter and ended up making a higher high.  I think this time will be no different as the selling has been overdone and will likely be made up for with reactionary upside move that retraces the market’s losses and takes the S&P 500 back up to its July high or higher by summer’s end.  

Everyone seems to be caught up in the fear this decline has generated that they’ve forgotten that despite the 8% dip, the market had risen 14% off the March low.  Before that the market had rallied 20% off the June 2006 low, only to correct 7% in March this year.  Before that the market rallied 14% off the October '05 low only to correct 8% into June '06.  You can see that these are just normal, healthy pullbacks in an ongoing bull market.  Most investors get too caught up in the short-term market noise and in doing so they miss the big picture (where the real money is always made).

Again I ask, why is everyone panicked over an 8% market correction?  To experience something similar to what we’re now seeing you’d have to go back to the summer of 1998.  At that time the global markets were being roiled, commodities were under pressure, the U.S. stock market was tanking and the yen carry trade was threatening to unwind (sound familiar)?  On top of that the collapse of Long Term Capital Management was threatening to put extra pressure on everything and many were worried that the global economy would melt down.

Fast forward to 2007 and we find the same story but with a different cast of characters:  fears over the yen carry trade are being voiced in the press, the highly publicized problems in the sub-prime lending market, a “credit crisis” being talked about every day.  But the one thing that has remained exactly the same is that the investors are panicking and assuming an “apocalypse now!” mindset concerning the immediate future of the economy and financial markets.

In 1998 the put/call ratio hit a high of 95 following the market panic low in September of that year.  This time around the S&P only fell around 8% to date as compared with 20-22% in 1998.  Yet the 15-day moving average of the total put/call ratio hit a reading of 122, its highest reading in almost 20 years!  The point being made here is that it takes a lot less of a market spill to panic traders and investors than it used to.  Some of this can undoubtedly be attributed to the growth in financial instruments and hedge fund activity but the public fear factor is still the same and is still the dominant component in the Total Put/Call Ratio.

Volumes could be written on crowd psychology in the financial markets and how mass media almost single handedly controls the thinking of the average retail investor.  Going opposite the majority opinion as reflected in the press is the most fundamental of all rules for successful contrarian investing, yet so many seem to disregard it.  In the book “Anna Karenina” by Leo Tolstoy we find a remarkable picture of today’s media-influenced man in the character Stepan Arkadyevitch Oblonsky:

“Stepan Arkadyevitch took in and read a liberal paper, not an extreme one, but one advocating the views held by the majority. And in spite of the fact that science, art, and politics had no special interest for him, he firmly held those views on all these subjects which were held by the majority and by his paper, and he only changed them when the majority changed them--or, more strictly speaking, he did not change them, but they imperceptibly changed of themselves within him.

“Stepan Arkadyevitch had not chosen his political opinions or his views; these political opinions and views had come to him of themselves, just as he did not choose the shapes of his hat and coat, but simply took those that were being worn…”

When will investors learn that the mainstream media isn’t their friend, it’s their enemy?  It pays to tune out the distractions of the mainstream press when the message it preaches is ubiquitous.  Why else would thousands of newspapers, magazines and television programs all preach the same fear-laden message concerning a credit crisis unless there was a supreme directive for it?  And what rationale could there possibly be for such a directive?  To help the masses avoid trouble and make money?  No, it’s done with the end of assisting Big Money at the expense of the Small Investor.  Indeed, this has always been the final outcome of the mainstream media’s headline games.