Written by William Kurtz
Last Friday's 120-point falloff in the Dow Industrials (and the concomitant falloff in the S&P 500) increase the likelihood that the October 5 peak will prove to be a lasting top. I've already mentioned the "rollover" pattern in the Dow and in the S&P 500, and the "Bearish Engulfing" pattern in the S&P. The "C" wave of the A-B-C upward correction in the Dow met its arithmetical target, and prices rose to the 78.6% retracements of the first drop from the tops, in the Dow and in the 500, and have been repulsed. Furthermore, we can count a clear "five waves Down" from the October 5 top. ("Five waves" means "this is the direction of the trend.")
Click on chart for larger image.
All of these are arguments for the proposition that the October 5 peak is a lasting Top, and that the operative trend switched from Up to Down at that time. These are elements of evidence. They do not constitute a guarantee; only a probability, but it's a pretty good probability. It is possible that, in spite of these elements of evidence, the Dow could climb to a new High. The "clincher" for the proposition that the operative trend is Down would be a drop in the Dow below the beginning of the countertrend "A" wave - that is, a drop below 12471.65, which was the Low on November 16. That number seems a long way off, but there's no way to tell how soon or how tardily it may be reached. The stock market continues to be sustained by an optimistic mood, which is a carryover of the long price rise from March 2009.
You'll certainly remember the long and destructive price decline from the all-time Dow top in October 2007 to the Low of early March 2009. Some investors missed the turn at the top. No doubt, some of them held on, all the way down, and finally threw up their hands at that March 2009 Low - and sold everything. That was exactly the WRONG time to sell, and it was also the RIGHT time to buy, because "the traffic light had just turned Green;" i.e, a major trend in the stock market had turned Up. And then, many folks did not jump back on the wagon again, because they did not believe that the advance was real. They were still traumatized by the decline.
There's something akin to an "accordion effect" going on, at major turns in the stock market. Imagine a long stretch of highway (not an Interstate), and a long group of cars, let's say 100 of them, safely separated, all traveling at 65 miles per hour in open country. Then, after many miles, a signaled intersection appears "out of nowhere." A red light! It stays red for a couple of minutes. All 100 cars eventually come to a stop at the light, and the spaces between them compresses way down. Let's say that the red light is the Dow Industrials Average, and the long line of cars is "group psychology." The red light had changed from green to red in an instant, but it took a long time for all of the long line of cars to react to it, to compress, and to come to a stop.
Let's imagine, further, that each of those cars has a driver-side button, and that when all of those buttons are pushed at the same time, the traffic light can be changed from red to green. All 100 drivers get it in their heads to push that button at the same time, and they do! What made them do that? Nobody knows. Maybe they just got tired of waiting. (Well, "we know this isn't a rando act. This same crew has done the same thing half a dozen times over the last 125 miles! We have them sized up pretty well. If they come to another red light, they'll act the same way.") Magically, the red light changes from red to green in an instant (i.e., the Dow turns Up, just as it did in March 2009). The lead car takes off, the "accordion effect" takes hold - in reverse this time, all of the cars get underway, and over the space of a few minutes all of them are rolling again and they are safely spaced once more.
That's the way the stock market and "group psychology" interact: The stock market turns quickly, as a result of a change in group psychology, but the participants are UNAWARE of that change - and it takes time for the EFFECTS of that changed "group psychology" to catch up.
That's what happened in the switch in the stock market from Up to Down in October 2007; that's what happened in the switch from Down to Up in March 2009; and that's what is going to happen this time, too. If the Dow did in fact come to a long-lasting peak last October 5 and has already made the turn (as is probable, but not yet guaranteed), "group psychology" will lag that turn. We can see that happening, right now: Stock market optimism is still way up; we read reports of "house flipping" again; car sales are good; more people are feeling good about the future of the economy than was the case a few months ago; the unemployment numbers are better than before; gasoline prices have come down; there is a spirit of "Can Do" after the devastation of hurricane Sandy; and the President has been re-elected. (This is not to diminish in the slightest our universal. bottomless grief with respect to the unfathomable, unspeakable event in Newton, Connecticut).
So it's all falling into place. Even if the stock market has "turned Down to stay" (which would be confirmed by a drop in the Dow below 12471.65, the November 16 Low), we can expect that "group psychology" will remain upbeat for quite a while longer, because it LAGS the Dow. On the other hand, if a new High is yet to come (which is the less-likely outcome), then "upbeat group psychology" will linger even longer.
This is how folks are deceived into staying invested after, and sometimes quite long after, the market trend has switched from Up to Down, as happened in October 2007; or in staying off to the side and not BECOMING invested until after, and sometimes quite long after, the market trend has switched from Down to Up, as happened in March 2009 - and they "missed the market." It's simply the fact that "group psychology" (as evidenced by its effects, such as "Christmas spending better than last year; encourages retailers") lags the stock market, and induces people to make the wrong moves or to not move at all, either of which can be deadly.
The moral of the story is not to be hypnotized by what you read about the state of the economy, or about good Christmas sales at the stores, or falling unemployment rates, or rising prices for new and existing homes, because all of those are EFFECTS, not CAUSES, of changes in "group psychology." Instead, keep your eye on the stock market; because what happens in the stock market is the CAUSE (broadly speaking) of events which occur later; it is not the RESULT of what is happening now. The stock market is the best measuring-stick of the state of "group psychology," the EFFECTS of which (such as personal spending) show up later. The stock market tells the truth; the media report on the economic "news," whether good or bad; and therein resides the Great Deception. The economic "news" is late, because it's a laggard. The economic "news" lies to us. The word itself is a re-arrangement of the letters of the points of the compass. It's unfortunate, in a way, because what we read in the economic "news" is not "new;" it's the result of a particular state of group psychology which existed in the past. In that respect, the economic "news" truly is "olds!"
The stock market tells it as it is. Do you remember Flip Wilson's act? One of his imaginary characters was Reverend Lee-roy, who was the pastor of "The Church of What's Happenin' Now." Imagine the Dow to be Reverend Lee-roy. When you attend the Dow, you attend The Church of What's Happenin' Now. If you will keep your eye on the Dow rather than on the economic "news," and make your investment and wealth-protection plans accordingly, you will be much more likely to enjoy financial success while staying out of trouble.
Why in the world would you want to join a game that's already been played?