The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

23 August 2010

Trends within trends

Are equity markets headed higher or lower? Either direction, what periodicity? Is that periodicity meaningful to your, and your portfolio's, time frame?

No question; confusion reigns. It is ever thus, however, when the market's primary direction is sideways. Sideways? Well, yes, if you step back far enough to see the market has traced a trading range for the past ~13 years, as it builds either a base or top. For the Dow Industrial Average, 7000 and 14,000 bound the range; for the S&P 500, 750 and 1500 are the boundaries. A 50% decline from 1500 to 750 or 14,000 to 7000 is painful, and qualifies easily as a bear market for most investors; for me, it is a high level consolidation (HLC). All the trading within the range can induce fright or elation, but amounts to noise and carries little significance. These high level consolidations appear quite regularly.

And every few decades, the equities market suffers through a secular variety of this pattern that typically endures for 15-20 years. (Single point: 16 years.) Many professional investors differ as to this pattern's inception; typically, from the high prefatory to the first 50% decline. I prefer to start counting from the breakout that is immediately tested subsequent to the breakout and then again during the 50% decline. Which dates the inception of this HLC since Q1 1997, and leaves ~3-5 years more work before a breakout or breakdown finally occurs. Too, the market trades (tags) the outer boundaries of the HLC only a handful of times during the HLC; all other trading occurs within the boundaries.

Rather than utilize pattern recognition, most investors, whether by choice or innocence, deal with news flow and pronouncements:
1) For every market move, the media must ascribe a meaning and a motive;
2) Market pundits pronounce the market's direction, rarely correctly but always willingly.

My interest is not to disabuse these pundits from making their predictions, only to encourage you to ask how those predictions and pronouncements effect your portfolio decisions. For example, Robert Prechter, an incredibly intelligent fellow whose notion of Socionomics is a direct descendant of Isaac Asimov's more interesting notion of Psychohistory, argues that the prevailing social mood today, ugly, paves the way for a materially lower market. Unfortunately for Prechter (and his followers), he has argued the same call for Armageddon -- and not just financial Armageddon, but societal Armageddon -- for the past 30+ years, while the market instead has climbed higher 15x rather than decline. Other investors point to their discrete data sets to argue for a bull market. I argue that until the market breaks out of its HLC, there can be no true bull or bear market. Careful, now, I care not at all for statistical analyses that state a decline of 10% is a correction, and 20% is a bear market; to me a bear market is a sequence of lower highs and lower lows, beneath a determinable break point. Until then, the boundaries form a base or top, its action expected. Yes, I know I have argued the HLC before (and repeatedly). Makes little difference, though, for the only other professional investor I know who shares this perception is David Rosenberg (Gluskin Sheff). Perhaps surprising, because most people view David to be a perma-bear. Their loss for not reading his commentaries carefully or diligently.

Oddly, perhaps paradoxically, but always profitably, during and throughout the market's secular high level consolidations, emerge new sector or group bull markets (as I denote the term): higher lows and higher highs to all time highs, and then some. This separate peace is where I live (invest). The trick, though, is to identify the leading groups and themes. And then time your investment purchases and sales to align with the general market's oscillations. So I slice the market into smaller epochal slices of one month, and base my expectations for the market on that thin sliver of time. Why one month? Because it equals one bar on a monthly basis chart.

Among market commentators, Tim Villano excels at recognizing the market's squiggles. Just this morning, Tim stated,
"Major sentiment surveys describe high levels of pessimism in the marketplace, and technical data continues to argue for an interim (intermediate term -- dmg) bottoming process. It would be unusual for the tape to break down or fall apart from the type of sentiment and technical readings currently seen. It would be difficult to sell the stock market short when the majority of participants, as described by the major sentiment surveys, are bearish. Under similar circumstances, I have seen the tape trade lower briefly or shake out more participants, but I cannot recall witnessing the beginning of a sustained declined from the type of sentiment readings present today."

Tim's comments always are more nuanced and balanced than the brief snippet above betrays, but the snippet above ably, if indirectly, argues my point: Do not fear the market; instead, trust yourself to make the right decision, the hard decision, when necessary. Which means pull your ear off the ground listening for the hoof-beats of history hurtling towards you. Listen, if you prefer, to your favorite market commentator -- but never forget to fit his or her predictions and pronouncements within your portfolio's needs.

50/50 that the market today builds an intermediate term base -- which grants equal odds the market instead could be building an intermediate term top. Increase the odds in your favor by buying the lower boundaries and selling the upper boundaries, until and when the market finishes its HLC and stakes a definitive, meaningful, and new trend. To my eyes, an intermediate term base within the market's secular HLC appears to build, and has the data to confirm such a likelihood. That said, demarcations of support must halt further declines beneath certain levels. Until proved otherwise, I seek to identify the new leaders, and invest at appropriate moments. (Never sufficient solely to identify the leader, and then purchase willy-nilly -- unless your time frame discounts wild swings in price.)

Full Disclosure: Specific investment opportunities, and their timing, discussed on Investment Poetry.
-- David M Gordon / The Deipnosophist


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