Entering the Puking Phase

Those of you who have been reading my previous postings since I began Pywrite in March, 2007 have been bombarded by my notion that psychology, not logic, is the better way to discern bear market bottoms. In other words, at bear market lows, a sentiment indicator of fear tends to be a coincident indicator while the economic fundamentals tend to lag.

Sentiment indicators are contrary indicators in the sense that a very high level of bearishness is a positive sign. Once the percentage bearish exceeds a threshold level last seen at previous bear market lows, the market tends to be at an attractive buying level. Investors Intelligence weekly questions investment advisors as to their feelings about the market and categorizes them as bearish, bullish, or bullish but awaiting a correction. In the past, when the level of outright bears reached 60% of advisors, that, in hindsight, proved to be a buy point. The percentage bears reached 53% in the latest published reading, but that sentiment didn't include last week's horrific decline. Unfortunately,the next reading will be published Wednesday and will represent the sentiment as of last Friday. While a rise from 53 to 60 would be a rare event in one week, last week's market action was the rarest of events. So there is the possibility that the 60 level was reached, but we won't know about that until midweek.

Another indicator of extreme fear is what is known variously as a "capitulation phase", a "selling climax", or a "puking phase". That occurs at the end of an exhausting bear market, when customers call their brokers and say, "I WANT OUT! I DON'T CARE AT WHAT PRICE!" Those occur very infrequently. They are characterized by 1) a violent downdraft in the morning, followed by a rally that takes the market at or near its previous day's close; and 2) very heavy volume. Friday's action resembled such an event. However, the volume, while very heavy, probably should have been higher, and this happened on a Friday. Rarely does a bear market end on a Friday because investors have the weekend to absorb the terrible news from the previous week and tend to panic on a Monday or Tuesday. A mitigating circumstance would be some very positive news emerging from the meetings among world leaders this weekend. Absent that, there could be climatic action on Monday or Tuesday.

As indicated in previous postings, I have been waiting until either a "puking phase" or a sentiment indicator of 60% bears before committing more money to equities. Friday's action sufficiently resembled climatic action to warrant putting to work some, but not all, of the remaining money held in reserve for equity investment. Accordingly, I invested one-third of that money in a Standard and Poor's 500 Index Fund at Friday's closing price of 900 in the Index. The remainder may be invested as early as next Monday or Tuesday.

Sometime in the near future, I will discuss what the market is discounting at a level of 900 in the Index, and what the upside potential and downside risk are at that level.