Warren Buffett once referred to the business cycle as being a natural progression of the “Three I’s.” The three I’s, as in, first come the Innovators, who see opportunity where most other do not (or are too fearful to act). Then come the Imitators, who basically copy the innovators while the going is still good. Finally, the Idiots come along, who spot what they believe to be a get-rich-quick easy money situation, betting heavily just as the innovators are cashing out their chips. In light of the price action in the market over the past several weeks, returning to Buffett’s aphorism is helpful for framing the big picture.
I have written several posts about those major, longer-term trendlines since 2009, namely in the S&P 500 and the historically market-leading Dow Jones Transportation Index. So long as they were intact, the high probability play was to stay long and strong. However, as you can see below, both of those overarching trend lines (colored purple) have been clearly breached on heavy selling amidst the market crash in recent weeks. Moreover, both the S&P and the trannies are flirting with losing their secondary support trendlines, dating back to the first major higher lows of the bull, back in July of 2009. Using history as our guide, though, it is unrealistic to expect a simple, steep trendline to last for the duration of the bull. As the saying goes, “Bull markets take the stairs up, while bear markets take the elevator down.”
Thus, even after the violent selling over the past few weeks, it is still against the odds to actively prepare for another 2008-syle bear market dive of over 50%. What usually happens is that the “obvious” trendlines break, causing many to turn bearish, only to see the market grind out a base before eventually turning higher. Of course, the lingering issue is that we are still in a structural/secular bear market that began back in 2000–Feel free to take a look at the monthly chart of the Nasdaq Composite Index to verify the longer-term bear. What that means is that the claws can come out at any time, as the early part of August has shown us.
The bottom line is that now is as good of a time as any to have a completely open, unbiased mind towards this market. I recognize that may be tough to do, as the temptation is to immediately chase back painful losses from the past few weeks, but you must allow a cooler head to prevail. There is smart money on either side of the trade at the moment, and the historical context of the current technical picture has me at an impasse. I am still sitting in mostly cash, and have been for roughly a week and a half.
Better to be boring than an Idiot.