Part 8 (1/2)

Here is how I dealt with this danger in 2003 First, stock ht months Indeed, in March 2003 the weekly survey of investors conducted by the American association of Individual Investors showed historically high levels of bearish sentiment The bear market had carried the S&P down by nearly 50 percent and the NASDAQ down by 80 percent It had lasted more than 30 months and thus exceeded the historical norround, the fact that thelow in March 2003 at 801, visibly above the level of its October low at 777 and in a situation as imminent, made me suspect that better ti h to see if the S&P could trade above its 933 high of November 21 If it did, then I would take that as preliun and switch to a bull ly as the Iraq war began and h on May 6 On May 2 the S&P closed at 930, e At that point every contrarian trader would have hard evidence that a new bull un

CHAPTER 14

The Postbubble Bull Market of 2002-2007 Bears at the 2002-2003 low pointsthe conservative contrarian increases his stock market exposure the conservative contrarian increases his stock market exposure30 months later he reverts to a normal stock market exposure 30 months later he reverts to a nor for a bullish infor for a bullish infor bubble the housing bubblethe aggressive contrarian during the bullthe bulla bulla bullopportunityMarch 2005 buying opportunity March 2005 buying opportunitytrading during 2006 and 2007 trading during 2006 and 2007 ESCAPING THE BEAR'S CLAW Like all bull an from the October 2002 low started amidst conditions of fear and loss of confidence in the US econo sideways near the low points of the 2000-2002 bear market The S&P 500 traded as low as 771 in July 2002, then as low as 768 in October 2002, and finally as low as 789 in March 2003

During that eight-month period, the bearish stockthe bearish infor Indeed, some polls of investor sentiment showed the maximum bearish sentiher price level in both the Dow Jones Industrial Average and the S&P 500 index than the October 2002 lows For example, the weekly sentiment poll conducted by the American association of Individual Investors showed nearly 60 percent of respondents bearish during the week of the March 2003 low point This was a greater bearish percentage than was seen at any ti the 2000-2002 bear market This fact convinced ration

By 2007 the Dow and S&P 500 would double from their 2002 lows at 7,181 and 768 respectively Hoould the conservative contrarian trader have positioned his portfolio to take advantage of this advance? In Chapter 13that on January 2, 2001, the 200-day e of the S&P had dropped 1 percent froh That day the S&P closed at 1,283 and the Contrarian Rebalancing strategy called for a reduction of stock market exposure to below-norns of a bubble were evident near the 2000 top

During a bear market that follows a bubble, the conservative contrarian maintains a below-normal stock market exposure He expects to see a drop in the S&P 500 of at least 30 percent Once such a drop has developed, he looks for a bearish information cascade to occur near a potential bearaverage of the S&P subsequently advances 1 percent fronal to increase his stock market allocation to above-normal levels

By October 2002 the S&P had fallen nearly 50 percent The May-October bearish information cascade had built the bear market crowd until its views dominated in the e of the S&P turned up by 1 percent That day the S&P 500 closed at 988 This upward turn in the 200-daythe entire 2001-2003 period On that day the conservative contrarian would have increased his stock market exposure to above-nory calls for a reduction of stock market exposure to normal levels once the bull market has continued for 20 to 24 months and the S&P has advanced 65 percent from its low point The low close for the S&P was 777 on October 9, 2002 A 65 percent advance on that loould carry the index to 1,282 On January 6, 2006, the S&P closed at 1,285, its first close at or above 1,282, and had advanced for more than three years At that juncture the conservative contrarian trader would have reduced his portfolio allocation to the stock market to normal levels

WHAT BULL? LOOKING FOR SIGNS OF A BULLISH INFORMATION CASCADE

As I have already pointed out, the 2002-2007 postbubble bull market nearly doubled both the Dow and the S&P and lasted five years One normally would expect to find an enthusiastic bull market crowd form in such circumstances But the trauma of the previous bear market, which had sent the S&P 50 percent lower and lasted nearly three years, apparently had very long-lasting effects on investors Perhaps this was because the bubble stocks that led the e stock in the S&P The bubble stocks for the most part were traded on the NASDAQ The NASDAQ Co the 2000-2002 bear ns of a bull market crowd and a bullish infor the 2002-2007 bull azine covers that favorably (even heroically) depict corporate leaders of prosperous industries generally appear during a bullish infor this bull market I noticed only one such cover story, which appeared in the October 24, 2005, issue of Tiraph of Apple Computer's founder and CEO, Steve Jobs, and was captioned: ”The Man Who Always Seeraph of Apple Computer's founder and CEO, Steve Jobs, and was captioned: ”The Man Who Always Seems to Know What's Next”

Another kind of bullish cover story conspicuous by its absence was one discussing the ”new” role of money and wealth in our culture and economic environment Typically these tell the story of the newly rich entrepreneurs who have beco stock s (IPOs)

A second sign of a bullish information cascade is a series of well-publicized and very profitable (for the corporate insiders at least) initial public offerings These were very pro the 1994-2000 bubble bullthe 2002-2007 bull le's IPO, which I will discuss shortly

A third sign of a bullish inforence of one or ists, or industrial leaders who are thought to have predicted the bullquoted in the press and otherthe 1996-2000 period, which saw the inflation of the prices ofthe 2002-2007 bullbullish stockand optienerally shows up in opinion polls of various kinds, in measures of consumer sentiment, and in discussions found in the media and in ordinary, everyday sorts of conversations about econons of such optienerally pessimistic about the economy and the prospects for the United States This e part to the prosecution of the Iraq war and the general concerns about terrorisenesis

A final sign of a bullish information cascade is the very well publicized bullish performance of one or more innovative business sectors and their co the 1994-2000 bubble bull y, and Internet-related sectors During the 2002-2007 bullstockand finance, but these sectors did not attract nearly the public attention that the dot-co bubble bull nificant bullish investment crowd of 2002-2007 occurred not in the stock reat advance in ho the 1995-2005 period certainly created the belief that invest was a sure road to wealth It would turn out that the collapse of this housing market investment croould have serious consequences in the stock market in 2008, but the crowd itself was not a stock market crowd I'll havemarket later

Since no bullish stockthe 2002-2007 advance, the conservative contrarian trader should have maintained his nores started to decline froh points In the event (see Chapter 15), this involved suffering through a drop in the S&P ofthe panic of 2008 However, there is good reason for adopting such a strategy, even when it can expose the trader to such risks The long-run invest coy takes these odds into account by being very careful before adopting a below-average allocation to the stockmistake a contrarian trader can e allocation to the stock es are advancing This would guarantee portfolio returns inferior to those generated by the buy-and-hold strategy Therefore, the Contrarian Rebalancing strategy demands a reduction of stock market exposure to below-nor, affirmative indications of a bullish stock market crowd in his ust 18, 2004, the search engine co (IPO) of its co was unusual in two respects: It was conducted by Google itself via an unusual Dutch or reverse auction, and this auction was conducted online Google had hoped to sell 257 e of 108 to 135, but in fact was able to sell only 196 loated at the apparent disappointing outcome of the auction Of course it was the Street's investle's decision to conduct the IPO itself instead of giving the Street's underwriters a substantial piece of the pie

But it was Main Street's reaction to the prospect of this IPO and to the event itself that I found nificant Investors had been burned so badly by the collapse of the dot-cole's IPO would fail They wanted the price of Google's newly issued co Such hopes about a widely anticipated IPO are highly unusual As a rule, there is a bullish anticipation of the IPO of any coy or cole had been in do the online search market Investors hope to make some quick profits on the IPO as it is oversubscribed But bullish sentile's IPO would fail They wanted the price of Google's newly issued co Such hopes about a widely anticipated IPO are highly unusual As a rule, there is a bullish anticipation of the IPO of any coy or cole had been in do the online search market Investors hope to make some quick profits on the IPO as it is oversubscribed But bullish sentile's IPO was nowhere to be found

Instead the public's attitude seele's IPO deserved to losedrop in the prices of the bubble stocks during the 2000-2002 bear ain, and would justify these investors' sour attitude toward the stocks of all tech and coeneral

In August 2004 I found this public attitude toward the upco It seemed that the bull market that had started from the 2002 lows had not yet entered a zone of overvaluation, and neither had a bullish stock market crowd been evident frole was the leading co, and it would tend to lift the price of Google's stock along with the general market Add these considerations to the evidence of the public's highly unusual bearish hopes and expectations about Google's offering, and you have a classic opportunity to fade this bearish stock le's stock performance

I told le was a buy at its IPO After the stock advanced from 85 to 200 I went out on a limb and predicted a move to the 500 level before the bull market ended Events proved le had risen to 747 The 2008 bear le to a low price of 247, but this was still nearly three tile's IPO the public's attitude could be seen reflected in the New York Times New York Times and the and the Wall Street Journal Wall Street Journal

On page 1 of the Tiust 19 edition there was a story headlined: ”Weak Dehts” The story was accompanied by a color photo of the news ticker in Tie” The story's lead sentence read: ”Google, conceding that de had fallen far short of the company's hopes, slashed the number of shares yesterday and concluded its unorthodox online auction by accepting a price well below its original target”

The August 19 edition of the Wall Street Journal Wall Street Journal had two Google stories The first was headlined: ”Is Now the Tih Price Is Noer, History Suggests Waiting Six Months to Grab an IPO” (Sixat 190) A second story in that day's had two Google stories The first was headlined: ”Is Now the Tih Price Is Noer, History Suggests Waiting Six Months to Grab an IPO” (Sixat 190) A second story in that day's Wall Street Journal Wall Street Journal said even more about the public's attitude The story's headline was: ”How Miscalculations and Hubris Hobbled Celebrated Google IPO,” and its subhead read: ”Euphoria Ebbed, Tech Stocks Sagged, Till Firm Cut Size; Priced at a Low 85 a Share, Blow to Dutch-Auction Method” said even more about the public's attitude The story's headline was: ”How Miscalculations and Hubris Hobbled Celebrated Google IPO,” and its subhead read: ”Euphoria Ebbed, Tech Stocks Sagged, Till Firm Cut Size; Priced at a Low 85 a Share, Blow to Dutch-Auction Method”

A few days later the Wall Street Journal Wall Street Journal published a colueneral Its headline read: ”Gloole's Entry” The thes to the public in the current market environment This was another solid piece of evidence that no bullish stock market crowd had foreneral Its headline read: ”Gloole's Entry” The thes to the public in the current market environment This was another solid piece of evidence that no bullish stock market crowd had forle's stock was nicely reflected in a Neeek Neeek column by Allan Sloan that appeared in the October 11, 2004, edition When Sloan wrote his story, Google was selling near 130 A week earlier five analysts had cole's prospects Sloan wrote: column by Allan Sloan that appeared in the October 11, 2004, edition When Sloan wrote his story, Google was selling near 130 A week earlier five analysts had cole's prospects Sloan wrote: Surprise! All five gave Google high ratings, even though it was a far more expensive stock than at the IPO just six weeks earlier, having risen almost 40 Why investors took these opinions seriously is a mystery to le's stock is going up because it's going up-not because its funda in ustAt soin wondering whether Google can earn enough to justify its 40 billion le's IPO in 2004 and of the public attitudes toward it and toward the entire IPO market then offers an iust 2004 the es had not yet entered zones of potential overvaluation, according to my historical tabulations There was no indication of a bullish stock market crowd in ly reinforced by the public reactions to the Google IPO and attitudes toward the IPO eneral at the time The conservative contrarian trader would have found it easy to sit with an above-nor this time because public attitudes toward the stock ht bearish Even better, here was an opportunity to fade a bearish crowd focused on a single coressive contrarian trader has to be on the lookout for these kinds of opportunities, because they will offer chances to enhance his perfore-traded funds (ETFs), which follow the broad market

THE HOUSING BUBBLE

The US stockthe first quarter of 2000 and then dropped to low points in October 2002 Re actually strengthened during the 2000-2002 bear market and the associated econo prices accelerated their upward trend during that time The Case-shi+ller index of US home prices rose nearly 90 percent between the first quarter of 2000 and the second quarter of 2006 This should be co the six-year period prior to 2000 The interesting thing about the housing bubble is that it idely recognized as a bubble by , but as with all bubbles this offered no clue about how high ho the bubble would inflate

This is a lesson for contrarian traders Bubbles are always always recognized as such by wise observers at the ti Sadly, this is no help to the investor; it doesn't tell you when the bubble is about to pop Bubbles as a rule inflate far beyond any reasonable expectation This is e call the example of this phenomenon in recent memory was the japanese stock nized as such by wise observers at the ti Sadly, this is no help to the investor; it doesn't tell you when the bubble is about to pop Bubbles as a rule inflate far beyond any reasonable expectation This is e call the example of this phenomenon in recent memory was the japanese stock market and real estate bubble of 1980-1990

japan's Nikkei stockthe 1970s As thethe 1980s one could read frequent commentary on japan's stock market bubble and predictions of its imminent demise Yes, the bubble did pop in 1990, but not before the Nikkei had advanced another 490 percent during the 1980s This ended a two-decade bull1,850 percent! If you studied the japanese market indoubled in the previous five years, you would have been teh level of prices to think the bubble was about to pop But you would have had to wait another five years and watch the market advance another 200 percent before you actually heard the popping sound!

The contrarian trader would have gotten so bubble was in its terminal phases The clues caazines

The first housing market cover I have in azine cover of its Septe and saying: ”They said prices would go up forever!! azine cover of its Septe and saying: ”They said prices would go up forever!!and we believed it!!” The cover headline asked: ”Is the Housing Boom Over?” and we believed it!!” The cover headline asked: ”Is the Housing Boom Over?”

This cover expresses skepticis boom Sometimes a bearish cover like this does does come near the end of a bubble This in fact happened in April 2000 for the stock market bubble As explained in Chapter 13, come near the end of a bubble This in fact happened in April 2000 for the stock market bubble As explained in Chapter 13, Neeek Neeek published a cover story then asking if the bull eneral, however, a bearish cover in thethat coveys little infor, it means that the bubble is not yet ready to pop published a cover story then asking if the bull eneral, however, a bearish cover in thethat coveys little infor, it means that the bubble is not yet ready to pop

The next two covers in my files tell quite a different story The May 30, 2005, issue of Fortune Fortune is headlined: ”Real Estate Gold Rush” It shows photographs of individuals and couples who have apparently made a lot of money in the real estate market The subhead reads: ”Inside the Hot-Money World of Housing Speculators, Condo Flippers, and Get-Rich-Quick Schemers (Is It Too Late to Get In?)” Teeks later, in its June 13 issue, is headlined: ”Real Estate Gold Rush” It shows photographs of individuals and couples who have apparently made a lot of money in the real estate market The subhead reads: ”Inside the Hot-Money World of Housing Speculators, Condo Flippers, and Get-Rich-Quick Schemers (Is It Too Late to Get In?)” Teeks later, in its June 13 issue, Ti an illustration of ahis hoa Over Real Estate”an illustration of ahis hoa Over Real Estate”

At the time these two covers appeared, in the second quarter of 2005, the Case-shi+ller housing price index stood at 17670, up 76 percent from its level of 10000 in the first quarter of 2000 By the second quarter of 2006 the index reached its high point at 18993 During the subsequent two years the index fell 20 percent to the 140 level

While these two cover stories gave fair warning of the end of the housing boom, they appeared a full year before the actual peak in home prices This is quite a coazine covers by anywhere fro bearish covers by only a month or so, if that

These covers ti sector of the stockThe housing stock price indexes maintained by Standard & Poor's and by the Philadelphia Stock Exchange reached their housing bubble tops in July 2005, barely a azine cover stories appeared By July 2008 these indexes had fallen 85 percent and 70 percent respectively froh points

The contrarian trader should always be on the lookout fora mature bullish or bearish crowd These can arise in unexpected places The housing bubble is a case in point The year 2005 saw the debut of two television series devoted to real estate speculation ”Flip That House” on the Learning Channel and ”Flip This House” on the Arts & Entertain and enthusiastic audiences Interestingly enough, both shows continued to air through the housing downturn as the flippers whose activities they recorded began losing money Apparently misery loves company

AGGRESSIVE CONTRARIAN TRADING DURING THE 2002-2007 BULL MARKET

Unlike his conservative cousin, the aggressive contrarian trader expects to make adjustments to his stockboth bull and bear oal is to use his e of the short-terer-term, multiyear trend In a bull ht carry the averages upward by 15 to 25 percent and last four to nine ht last anywhere from one to three months (and in extrees doard by 5 to 15 percent In a bear s is sis in a bull market A sis in a bear ressive contrarian trader will have an above-normal portfolio allocation to the stock s and a normal or below-norh points of short-ters

At this juncture let erous I don't think any contrarian trader should have a below-nor a bulla below-nor in prices is a recipe for ensuring that your portfolio's performance will be inferior to that of the buy-and-hold benchressive contrarian traders to allow their bull market stock market allocations to fluctuate between norressive contrarian would move to a below-normal allocation only after he sees the S&P drop 5 percent below its 200-day e A below-normal stock market allocation is justified only in a situation where a stock market bubble has likely formed and is probably about to pop In all other situations, leave below-normal stock market allocations to expert contrarian traders

Let's see what tactics an aggressive contrarian traderthe 2002-2007 bull an its bull market froressive contrarian trader would have had very strong evidence that a new bull in Certainlythe summer of 2002 revealed a er than those evident at the March 2001 and September 2001 low points By October 2002 the bear e down nearly 50 percent, thus50 years I think the conjunction of these two facts ressive contrarian trader to act on the assuin