SAN DIEGO (ETFguide.com) - Successful investors often stick to time proven rules, such as: 'buy when blood is running on the streets' or 'be greedy when others are fearful.' London financier Rothschild and Warren Buffett made millions and billions this way.
As a whole, the stock market is the most accurate reflection of investor sentiment. A constant battle between the fear of losing money and the fear of losing out on making money drives the markets up and down.
We referenced this phenomenon in our ETF Profit Strategy Newsletter. The forecast we gave protected our subscribers from a 2,000 point drop in the Dow Jones. On December 14th, with the Dow Jones (AMEX: DIA - News) trading at 8,600, we predicted the following:
'Range-bound trading, as we've seen over the past several weeks, grinds and tests the patience of investors. More importantly, it gives the stock market a chance to calm extreme levels of investors' pessimism. Conversely, optimistic sentiment, which should be more visible above Dow 9,000, gives way to further declines. These should draw the indexes close to or below their November 21st lows of 7,445 for the Dow and 740 for the S&P'.
Investor optimism seen in the beginning of January '09 rivaled bullish sentiment surrounding the October 2007 market top.
Since our bold market forecast, the Financial Select Sector SPDRs (NYSEArca: XLF - News), the Dow Jones (AMEX: DIA - News), the Russell 1000 (NYSEarca: IWB - News) and the S&P 500 (AMEX: SPY - News) dropped below their respective November 2008 lows. The Dow Jones Transportation Average (NYSEArca: IYT - News) also fell to new lows, thereby confirming a Dow Theory bearish signal.
With a 4.5% cushion before reaching new lows, the Nasdaq (Nasdaq: QQQQ) is the last Mohican still standing. In an ideal world, the Nasdaq will have to sink to new lows before the overall market can bottom.
Those who don't learn from history ...
Is there enough blood on the street to call a market bottom? To answer this question, let's revisit a few cornerstones of extreme investor sentiment.
At the tip of the technology craze, investors couldn't gobble up dot.com stocks fast enough. Mothers with kids and seniors waited in lines to open up brokerage accounts with their local (online) broker. The Technology Select Sector SPDRs (NYSEArca: XLK - News) have given up over 80% since their March 2000 high.
Mutual fund managers, the alleged pros of the investment world, held a record low 3.5% in cash right as the Dow Jones and S&P 500 climbed to all-time highs. This means that 96.5% of investor's money got to 'enjoy' the subsequent stock market meltdown.
As soon as the average Joe realized that basic shelter has morphed into a mainstream investment, real estate prices started to tumble. The SPDR Dow Jones Wilshire REIT ETF (NYSEArca: RWR - News) dropped nearly 70% since its February 2007 high.
A spike in gas prices and forecasts of $200/barrel crude oil moved General Motors, Ford and Chrysler to retool entire factories in order to manufacture predominantly fuel efficient cars. As those plans were implemented and hybrid Toyotas and Hondas replaced gas guzzling Tahoes and Denalis, oil prices (NYSEArca: USO - News) started to tumble, falling as much as 80%.
Similar optimism surrounded gold's (NYSEArca: GLD - News) all-time high in March 2008 and again today. Even though gold recovered from a 30% drop after reaching its lofty levels, on a smaller scale, the recent rebound is reminiscent of the stock markets double-top (2000 and 2007) which was followed by a once in a lifetime meltdown.
History truly shows that markets start to tumble as soon as everyone believes that higher prices are here to stay.
Is now the time to be greedy?
As you can tell, the time to be fearful is clearly when others are greedy, in other words: sell when others are buying.
On the flipside, no doubt there is validity to Baron Rothschild's observation to buy when blood is flowing on Wall Street.
The key question is whether there is enough blood flowing to call a true contrarian market bottom.
A look at the first page of the Wall Street Journal shows that we must be close to a market bottom. We will discuss later whether this is THE market bottom or just another decoy bottom as seen last November.
Here are a few front page headlines: Economy in worst fall since '82, GDP falls at the fastest pace since 1982, GE joins parade of deep dividend cuts, Lloyds Banking faces bleak outlook. USA Today reported that 'virtually nobody at this point believes there's light at the end of the tunnel.'
The Conference Board's Consumer Confidence Index fell to 25 in February, the lowest reading since the index was first compiled in 1967. Even some members of the Fed's interest-rate committee believe that a full recovery is more than five years away. Within less than 18 months, investors have lost some $12 trillion in equity investments and some $10 trillion in real estate investments.
A look at the facts shows: 1) Yes, there is blood on the streets and 2) This is not your average recession.
We've been warning our subscribers of the uniquely hostile nature of this market since before the first $700 billion bailout. The ETF Profit Strategy Newsletter has established a history of being a step ahead of the market. Our January 15th issue marked Dow 6,700 as the target level for the next bear market bottom.
As of today, the indexes are a mere 3% away from our long-standing target levels. How can you limit your downside risk without missing out on the upcoming rally?
On Sunday we sent out a trend change alert with specific strategies for conservative, moderate and aggressive investors. Some strategies involve plain vanilla ETFs such as the SPDR DJ Wilshire Total Market ETF (NYSEArca: TMW - News) while others include high octane contrarian plays such as the Ultra Financial ProShares (NYSEArca: UYG - News) and Ultra S&P 500 ProShares (NYSEArca: SSO - News).
I promised above that we'd circle back to discuss the issue of a big picture, long-term market bottom vs. a brief short-term, snap shot bottom.
Just as a marathon runner's training equipment differs from a 100-yard sprinter's, a long-term market forecast requires an analysis of indicators unrelated to short-term signals.
Four such long-term analytical tools are dividend yields, P/E ratios, investor's sentiment and the Dow measured in real currency, gold. A look at previous bear markets shows that all four indicators need to reach certain levels before the market is able to bottom for good.
Indicative of the implications, we have named those indicators the 'Four Horsemen'. The most recent issue of the ETF Profit Strategy Newsletter contains a detailed analysis of these four reliable investment guides along with detailed target levels and corresponding profit strategies.