String Theory

While in many ways the capital markets resemble what academics refer to as a "random walk", there is a hidden structure to how they work.  The majority of investors believe that earnings are what's important.  They are eventually, but NOT in the short-term.  Valuation only provides us with guidelines, but says virtually nothing about timing.  As they say, "Timing Is Everything".

The markets have now rallied for 14 of the last 16 days.  Statistically, that's virtually impossible.  In, addition, The Dow Jones Industrial Average (Dow) has had triple-digit gains 3 days in a row.  That's unprecedented.

Strings of up and down days are followed by very few analysts.  Not too long ago, I studied market strings.  Here's what I found:

A streak of 7 days up or more is exceedingly rare.  In fact, virtually every occurrence marked either a significant market top or bottom.  These strings suggest exhaustive moves.  Terminal moves.  Moves subject to sharp and violent reversals.  The same goes for strings such as 11 of 13 days or 9 or 10 days.  They feel good, but they do NOT indicate market health.

The 2008-2009 market meltdown witnessed 8 down days in a row.  This marked the the final panic lows.  Now, we have an even more extreme string up.  The waterfall decline we've been anticipating is all set up.

Markets make major turns at extremes of investor sentiment.  Once everyone has bought in, and all the short-sellers have been forced to run for cover, who's left to buy?   NO ONE!  That's what makes the current string so dangerous.  Everyone is bought in.  Everyone thinks earnings will carry stock prices higher.  The analysts warning you about coming problems have been temporary discredited. 

The largest percentage moves up occur in bear market rallies.  Virtually all of the 10 largest percentage moves up occurred either during the Great Depression or during the meltdown of 2008-2009.  They're a sign of emotional extremes, NOT of market health. 

Bull markets progress gradually.   The bull's job is to make sure that as few people as possible ride the wave up.  It's never easy.  Any major move will have intermittent market smashes designed to scare the hell out of anyone.  They are there to make you question your convictions.  Bear market rallies are designed to keep you bullish, to keep you from selling and to make sure you hold your stock all they way to the bottom.

Thus, while it's tempting to conclude that this recent move up is indicative that "all's well", nothing could be further from the truth.  All the extra-ordinary fundamental problems still exist.  They are far from being solved.

So, if you're cautious but looking at the recent sharp move as indicative of a recovery, think again.  The same type of sharp upward corrections have NEVER been indicative of a good buying opportunity.  They don't now. 

Remember, the key to this right now is SURVIVAL.

Marko's Take