Almanac Update for the Week, Scenarios for the Months

The Almanac this week is showing a few signals: a bullish Tuesday, bearish Thursday, and a bullish Friday. This does not seem terribly implausible: we get a brief rally this Monday, then a fall off and plunge in the middle of the week, and a slight come back on Friday. As I look at the market, I see a couple of possible scenarios for the coming months ahead. I have been looking at the market of the early 30s which parallels our market well in some places. After every, or almost every, bear market, they have ended with a strong move upwards followed by chop. So I have two scenarios when I look at this market. This up-move was definitely violent and swift, and if the bear market is “over” in the sense of continuous falling prices, we will see this down move level off into chop. I would imagine that we would get a large sell of day, a panic day per say, after which we would gradually retrace it and then get into this up/down movement for awhile. For an example of this, look at the 100% July rally in 1932 that extends for a couple months, and then simply chops low for the rest of the year, at which point it blasts off to the upside at some point down the road. So scenario 1 is that the bear market is over, and we are in for some chop. Whether that chop develops into a new bull market is not my real concern.

Scenario 2 is that the bear market is not over, and that new lows will be seen ahead. This down move will develop into a more severe retracement, at which point people will start buying because of the great “deals,” out there. It will not be long before people realize that the down move is no retracement. Then in comes the panic, and the selling that will lead us to new lows. A good example of this would be the 1930 December rally, which topped out, and then fell into a chop zone, and then fell further.

At this point, the first scenario seems more plausible to me, for several reasons. First off, the rally that we just had seems to have a lot more in common with the sharp reversals off bear market lows that I have seen in historical bear markets, not the mini bear market rallies that lead to lower prices. Also, I think the stimulus money is literally like a tsunami that has been unleashed into the system. When it finally really catches, I believe everyone will be surprised at the virulence of that pill that the government swallowed. In my eyes, that much money floating around will (sadly) change the entire market system as money chases returns and interest rates shoot through the moon.

The government rarely, if ever (I am sure you could count the times if you used all your toes), seems to get anything exactly right with the economy. The decisions they made about what to “do” about the falling economy came under panic conditions, and a failed president walking out the door. If I were a betting man, and I am, I would say the probability that they made decisions that will have the desired effect is miniscule, and I will bet anything that they made them on the “too much” side.

Notice how I am not bashing the government actions and calling them plainly wrong, only emotional. I cannot know how their decisions will play out across the system, it is much too complicated for me to comprehend, and I really do not have any edge in thinking of political scenarios. What I DO know about are emotional decisions (from personal experience). And I DO know that when you make emotional decisions, rarely are those problems solved, and rarely do you have a lessening of emotionality, which leads to a vicious cycle that feeds upon itself.

So to sum up, I expect scenario 1 as more likely, but I add in scenario 2 because I see its likelihood as well (It’s a bear market you know!). The fact is, this rally surprised me; I did not see this coming at ALL. So I have to include the possibility that, although it does not seem in the cards, a full on melt down will occur and new lows will be reached. I am preparing for both scenarios in my stock long and stock short positions. At this time, the choice depends on what we see in the next couple months. Have a great trading week!