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Market Timing

Saturday, 11 May 2013

As with almost everything in this world, the behavior of the stock market is made up of actions from millions of people.  And, as with almost everything in this world, the stock market does kind of repeat itself.  The $64,000 question is what is repeating and when?

This week I saw a talking head on CNBC discussing what was going on in the market and why, and if the current 5-year bull market would continue.  Like most others, he gave a very nondescript answer.  His  short answer (and my interpretation of his answer) was that the action of the stock market would follow one of the options below:
   1) Rational Exuberance - 60% (that is, keep going up as it should)
   2) Irrational Exuberance - 30% (that is, going up faster, even though it should not)
   3) Market Crash - 10% (that is, a complete reversal from today's bull market action).

This reminds me of three market behaviors of the Nasdaq in the 1990's (when Alan Greenspan coined the term "Irrational Exuberance").


Graph 1 - Rational Exuberance 
This graph shows the Nasdaq from 1985-1995, when the index TRIPLED, but did so because technology was booming. This fits "Rational Exuberance" because everyone was happily making money on the high growth of companies like Microsoft, Oracle, Cisco, etc.  In this 10-year period, the Nasdaq rose in value from about 250 to 775, ending with "overbought" conditions, nose-bleed P/E ratios (Cisco had a P/E ratio of over 100), etc.  Then, the pundits were were crying, GET OUT!!!
Were they right?


Graph 2 - Irrational Exuberance
Of course, the pundits were right about the fundamentals, but DEAD WRONG about the Nasdaq market performance
- the proof lies in the following 5 years' performance [that is, in the time period of 1995-2999 (Graph 2)]
- this is when everyone (especially the little guys) went into panic buying ("Irrational Exuberance")
- the net result over this 5-year period was that the Nasdaq  WENT UP OVER SIX-FOLD, from 775 to 5000, with
  crazy things like Cisco's P/E ratio growing to over 400, Yahoo's market cap being more than the GDP of Iceland, etc



Graph 3 - Market Crash
We all know that US stock market indices went up in smoke after the year 2000, but getting out in 1995 was way too early. 



OUR POINT IS THAT SINCE THE MARKET DID RECENTLY BREAK TO THE UPSIDE AND SET NEW ALL-TIME HIGHS, AND IF THE BIG GUYS GET THEIR WAY, THE LITTLE GUYS CAN PUSH THIS MARKET WAY HIGHER THAN IT SHOULD GO (like 1995-2000), AND THEN THE BIG GUYS WILL DUMP BIG-TIME (like 2000).

BUT, IF THE LITTLE GUYS ARE NOT ABLE TO KEEP THE SPY ABOVE ITS CURRENT RESISTANCE LEVELS, THE BIG GUYS WILL MOST LIKELY SELL DOWN.  OF COURSE, THIS CAN RESULT IN (1) A RELATIVELY SMALL DIP WITH A CONTINUED UPTREND OR (2) A BIG MARKET CRASH (like 2000).

We certainly can't predict what will happen from here, and that is why we developed and follow the MIPS models.  If and when this market makes a major change,  MIPS will most likely miss a minor part of the change, but will find and follow the resulting trend.  And, MIPS should ignore minor changes to prevent getting whipsawed.

 

Posted by: Dr. G. Paul Distefano AT 04:00 pm   |  Permalink   |  Email

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