Stock Market Crash Course: Positive Expectations

In today’s Stock Market Crash Course, majority opinion says that the market will experience a short correction before testing pre-crash highs this Spring. But in a contrarian exercise, I look at what the other side is saying. Includes views from The Stock Traders Almanac, Cabot Options Trader, Technical Disciplines and The National Investor.

Chloe Lutts, Editor of Dick Davis Investment Digest and Dick Davis Dividend Digest

Chloe Lutts is the editor of Dick Davis Investment Digest and Dick Davis Dividend Digest, and the third generation of the Lutts family to join the family business. For each Digest, Chloe reads hundreds of investment newsletters to select the strongest ideas for her readers. Prior to joining the Dick Davis Digests, Chloe was a financial reporter for Debtwire, a division of the Financial Times, covering fixed income, and before that, she reported on global debt markets for Institutional Investor. She also has previous experience at Cabot, writing about growing momentum stocks for Cabot Top Ten Trader and high-potential small companies for Cabot Small-Cap Confidential. She holds a B.A. in International Relations from Brown University, and also studied in Beijing and Paris.

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>> Hi. I’m Chloe Lutts, editor of the Dick Davis Investment Digest and Dividend Digest and this is what Wall Street experts are saying this week for February 17, 2012. The main theme in the market this week is expectations that the market will encounter a short term correction and then go on to best, or at least test its pre-crash highs this spring, sometime around April. This sentiment was best summed up by Christopher Mistal, one of the Stock Traders Almanac editors, who wrote on February 9th: “The market has stalled at resistance and could be prone to a brief pullback before finally finding the strength to cleanly break out to new recovery highs across the board later this spring. Technicals and sentiment are at really similar levels to this time in 2011 and even in 2010.” He used this graph to show the historical correlation between last year, the year before, and what’s possible this year. He writes, markets were near resistance then and sentiment was excessively bullish. In both of those years the market suffered a pullback, at the lower arrows here, before charging on to new recovery highs in April; the upper arrows. Will the market repeat this performance in 2012? At this junction, historical seasonalities suggest that it is quite likely. Barring some truly disastrous event, a brief pullback from resistance followed by a rally to new recovery highs later this spring, does appear to be the path of least resistance for the market at this time.

Also calling for a short term correction followed by new highs is Rick Pendergraft, editor of Cabot Options Trader, who wrote on February 13th, “I would like to see a small pullback in order to move the indexes out of overbought territory. On the turn of the S&P, there’s a trend line that connects the lows from 2009 with the lows from last September and November. This trend line is just below the 1200 level. You can see that here. There is also potential support at the 1217 level, which was the temporary high in April 2010. That is this horizontal line. The trend line and the flat line support could serve as a target buying point on a pullback. From Friday’s closing price down to the 1217 level would represent a drop of almost 10 percent.”

So that is the majority opinion right now. Of course any time you have a majority opinion in the market, you have to be worried because it is good to be a contrarian. So, on the other hand, we have a few pessimists, like Technical Disciplines’ Rex Takasugi, who wrote that he thinks the market is overbought and investors are overly bullish. He’s cited a bunch of sentiment surveys and showed some charts that showed that investors have been piling their money into the market. However, he does note that overbought markets can stay overbought for longer than you expect. He wrote, “Timing stock market tops is much more difficult than timing bottoms, as greed is not as strong an emotion as fear. In spite of all these current sentiment charts showing extremes in investor sentiment, my recommendation is to wait on turning the stock market.”

Also in that camp is Chris Temple, editor of The National Investor, who reveled in the market’s opening lower on Tuesday, writing, “This morning’s news seemed to have ended for now the latest transfer the stock market to meaningfully vault above the old highs from last spring. Already it was evident that there has been somewhat of a force field coming in the bulls at about the 1350, 1360 level on the S&P 500. For starters, this key level represents the peak reached a few times last year prior to the market falling off the cliff in August. As is generally the case, investors who were caught by that move down are now looking to get out since they’re back to even. This is one factor keeping stocks from breaking out.”

You can clearly see those trading levels on the chart here. Of course the experts we heard from earlier think that the market will consolidate and then bring it up to the upside. He does not think that will happen and continues adding that the market has been working itself ever more narrowly into what technicians call a bearish rising wedge. You see that on the chart here. More often than not, the break for stocks ultimately is one lower out of this wedge as the volatility and corrections that have been absent on the way up, reassert themselves. We’re convinced that such a break lower is about at hand. Finally, on top of the people who see bearish technicals and overly optimistic sentiment, there are the people who just simply think everything is going to hell in a hand basket and I won’t tell you what newsletter this is from, but someone recently wrote, political risk is disgustingly high. Entire continents are on the verge of monetary implosion and anger among citizens in every corner of the world is at a boiling point. From here, it is not a question of if we see a systemic meltdown, it’s when. So to me, all those pessimists say that the people calling for a test or breakthrough of the pre-crash highs this spring, might actually be on to something. Of course you might think they’re right. That is all the time I have for today, so I hope you join me again in 2 weeks for the next edition of What Wall Street Experts Are Saying This Week. Thanks for watching.

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