Thursday, October 6, 2011
This is what we've been waiting for ever since the market crashed in early August.
The market is playing out the final act of the "post-crash" script we highlighted several weeks ago. Specifically, we got the crash. We got the enthusiastic bounce that reinvigorated the bulls and punished the overly aggressive bears. Earlier this week, we got the retest – and slight undercut – of the crash-time lows.
This is how crashes work. It happened in 1987. It's happening now. And it's setting up the best stock-buying opportunity we've seen in years.
Take another look at this chart of the S&P 500 from 1987...
Now look at what's happening today...
It's the exact same pattern.
I pointed this out a few weeks ago, not because it was an interesting coincidence – it's not – but because this is, in fact, how crashes always unfold.
You see, economic conditions can change. The reasons behind sharp moves lower in the stock market can vary. But human psychology doesn't change. People react to stock market crashes the same way, regardless of the fundamental reason behind the crash.
That's the real value of technical analysis. Charts are visual representations of investor psychology. We don't use charts solely to draw a bunch of support and resistance lines and try to predict the future direction of stock prices. We use them to understand how investors previously reacted to the emotions of fear and greed so that we can better understand how they'll react when faced with similar conditions.
The chart of the S&P 500 in 1987 illustrates how investors reacted to that crash-type scenario. It's no surprise that today's chart is playing out almost exactly the same way.
When we started off 2011, most stock market analysts were bullish. They cited the "presidential cycle" as the primary reason stocks would go up this year. Since 1940, stocks have gone up during the third year of a presidential cycle, and the average gain is 22%. So why not expect something similar this year?
I wasn't quite as bullish. I conceded that stocks would likely end 2011 higher than where they began it. But I was worried about what might happen along the way. In fact, I often commented about how things "felt" eerily similar to 1987.
It just so happens that 1987 was also the third year of the presidential cycle. And while most investors remember the crash of 1987, many probably don't realize that stocks actually closed the year higher. The S&P gained just about 4% in 1987. So if you bought stocks on December 31, 1986, you made money – despite the crash.
However, if you bought stocks after the market retested the 1987 crash-time lows, you made 15% in just a few weeks.
We have a similar opportunity today.
The S&P 500 started the year at about 1,250. It closed Monday at 1,100. At this point, if the S&P 500 just gets back to even for the year, we're looking at a gain of almost 14% over the next three months.
You have to buy something. There's just no other way to put it.
We are looking at the exact opposite of the situation we had in April, when I told my sister-in-law not to use cheap cash to buy expensive assets. Today, cash is expensive and assets are cheap.
You don't have to jump in all at once. In fact, since the S&P has already rallied 7% off Tuesday's low point, you may want to wait for a brief pullback before putting money to work. But this is the time of the year to start buying the dips.
Take advantage of weak days in the market to start building positions.
Best regards and good trading,
As you slowly get back into stocks, keep in mind Matt Badiali's shopping list of resource stocks. "These companies are the biggest, brightest stars in the commodities universe," he writes. "Each one of them owns a portfolio of the best assets in the industry."
Also consider Steve Sjuggerud's watch list... "My point is simple: These stock markets are dirt-cheap," he says. "When they get this cheap, you can make a lot of money." See how you can get a jump start on this mega-bull market here: Emerging Markets Typically Soar From Current Levels.
Gold is the only commodity still trading above its critical 200-day moving average.
The "retest" continues... S&P 500 is sitting at the same level as it was after the "crash" in early August.
Large-cap tech stocks are holding up... IBM, Oracle, Intel, and Cisco are all in positive territory over the past month.
Agricultural commodities aren't faring much better than stocks... corn, wheat, and cotton are down more than 20% in six months.