Macro Wrap – “Nobody Wants to Miss That Bounce”

by Enis October 4, 2013 7:41 am • Commentary

One of my favorite trading books of all-time (and I’ve read dozens) is The Psychology of the Stock Market by G.C. Selden, written in 1912 (for those who want the free pdf copy, here is the link from the California Digital Library).  I’ve quoted the book in this space before.   Selden’s words seem particularly relevant today because of the numerous mental gymnastics taking place in traders’ minds about the price action before (and the expected price action after) the debt ceiling / government shutdown is resolved.

Before I get to Selden, I wanted to highlight the type of commentary I’ve seen abundantly from fellow traders over the past couple weeks as the political deadlock has dragged on.  Jeffrey Dow Jones, an investment manager at Alpine Advisors and astute market watcher, wrote the following in his weekly commentary blog:

I know this isn’t the first government shutdown, but there are few meaningful parallels today. I’ve seen a lot of analysts look to ’95/’96 for answers and I just don’t think those data points have much relevance. This is new territory.

So far, the stock market hasn’t seemed to care all that much. It’s down, but not down any more than one might expect with some new macro uncertainty as part of the basic backdrop. It hasn’t devolved into chaos and panic yet, though it certainly could. And I don’t see any way that this thing doesn’t result in some kind of rally once it’s resolved. In fact, that could be one of the main factors holding the market together right now. Nobody wants to miss that bounce.

I discussed that psychology in my Macro Wrap last week when I detailed the price action into and out of the 2011 debt ceiling resolution (note that I said resolution, as an eventual deal was reached, and the market initially rallied, but then fell apart AFTER the deal occurred).  Here is what Selden said more than 100 years ago about buying the rumor / selling the news, and vice versa (emphasis mine):

After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions be- come too complicated. Be suspicious of bull news at high prices, and of bear news at low prices.  Bear in mind that an item of news causes but one considerable movement of prices. If the movement takes place before the news comes out, as a result of rumors and expectations, then it is not likely to be repeated after the announcement is made; but if the movement of prices has not preceded, then the news contributes to the general strength or weakness of the situation and a movement of prices may follow.

As we consider whether the market will rally (and by how much) after a deal is reached, the sentence is bold does not get enough attention in the current debate.  Traders have been especially affected by the rally after the resolution of the fiscal cliff to start 2013.  Most traders likely have a recency bias as a result.  But there is one HUGE difference between the late 2012 fiscal cliff debate and today’s government shutdown / debt ceiling debate:

Stock prices are more than 20% higher.

That’s it.  That’s the huge difference.  SPX earnings are up about 3%, and the SPX index is up about 25% from late 2012.  Meanwhile, market breadth and momentum have been deteriorating since May.  The eventual reaction that we get to any resolution is more likely to be impacted by the positioning of the potential buyers and sellers than by the simple calculus that seemingly prevailed after the prior debate.

“Nobody wants to miss that bounce.”  That’s with the SPX at 1680.  Last year, it was more like, “Nobody wants to hold through that selloff.”  That was with the SPX at 1380.  What’s your next move?