Panic in the Streets, Fear in the Air!

By: Clif Droke | Thu, Aug 2, 2007
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Did you hear that sound last week? That was the collective sound of millions of retail traders and investors screaming in fear and running, not walking, to the nearest bomb shelter as the stock market put in its internal low. Once again the ever-growing fear of the Main Street masses has led to capitulation at what looks to be another important stock market bottom in the making.

The June 29 edition of the Financial Times showed a picture on the front page of an exasperated Wall Street floor trader with his hands covering his face following a hard week of losses for equities. The S&P 500 was down over 5% in what was the biggest decline since the late February selling panic. The headline for June 29 read "'Wake up call' for investors" in reference to the statement by Treasury Secretary Henry Paulson who said, "I think [investors] could use some more discipline. We are seeing a reassessment of risk and that is leading to a market adjustment." When a high ranking member of the government pontificates on the dangers and excesses of the financial markets it means the worst has been seen in this latest correction and it's time to look past the rhetoric and do some nibbling.

To illustrate the heavy fear hanging in the air over the latest "crisis of the hour," here are a collection of headlines from that same newspaper over the past few days: "Subprime fears hit financial offerings," "Subprime and credit fears give rise to volatility," "Flight to quality over credit concerns," "Shares battered as mortgage fears rise," "Dollar rallies on US subprime fears," "Bank debt fears spark big share price falls," "Credit crisis puts heat on liquidity," "S&P paints a gloomy picture for big banks," "Credit gloom intensifies after double whammy," "S&P plunges 2.3% amid earnings and housing gloom," "Equity investors join exodus as mood darkens."

I'm sorry, what was it again the press wants us to be afraid of? Oh yes, a credit crisis! (And if we believe the reports it's going to get us all!) In reality, of course, this graphic display of fear and gloom show us that as investors we should be feeling the exact opposite of what the press is preaching, namely optimism over the U.S. stock market outlook.

The internal low of last week's decline occurred on July 26, a day that saw the 52-week new highs/new lows on the NYSE fall to -620 in what was probably the lowest 1-day reading of net new lows in the last three years. This typically means investors have just about thrown in the towel on stocks, marking the worst part of the correction. Since then the number of stocks making new 52-week lows has gradually shrunk until today (August 2) when the hi-lo differential was -171, a vast improvement over the past two weeks when the average hi-lo disparity has averaged well over -300. Clearly the broad market is showing signs of gradual internal improvement.

Another indication that the worst of the latest correction is behind us is the massive spike in downside volume last week. On July 24 the advance-decline volume ratio on the NYSE was nearly 1:14, a clear sign of capitulation on the part of mainstream investors. Not only did the few remaining retail investors throw in the towel last week, they made it clear in the way of leading investment publications that they expect worse things to happen in the weeks ahead. I clipped the following from the financial web site from Wednesday, August 1, since it shows what many investors are thinking right now:

"Further underscoring today's bearish tone has been a 10% surge on the VIX (CBOE Volatility Index) to its highest level in four years. Known as the "investor fear gauge," the spike higher suggests investors are actively buying put options in anticipation that too much money floating around will lead to more market declines, with things likely getting worse before they get better."

What the above commentary from Yahoo's financial writer doesn't mention is that a spiking VIX reading is seen as a bullish sign from a contrarian standpoint. Since the average investor things that things are "likely getting worse before they get better," we can anticipate the opposite will happen with the worse likely already behind us.

Even more impressive is the fact that the 5/10/20-day oscillators for the S&P 500 (SPX) have all decisively entered into oversold territory and this has historically marked a good starting point to do some nibbling in anticipation of a price bottom. The bottoming process itself will likely take several more days, just as it did following the Feb. 27 sell-off. But a meaningful rally should eventually follow this bottoming process just as it did after the March lows in the major indices, rewarding the patience and fortitude of investors who look beyond the current fear. The SPX oscillators are saying that a rally isn't far off and it should be a meaningful one.

One of the best indications we have of a worthwhile bottom in the making is the fact that according to insider trading data, the "smart money" and institutional investors are heavy buyers of stocks right now, just as they were following the late February/early March panic selling. In fact, according to the latest data the insiders are now buying stocks at their heaviest pace since the last bear market ended in March 2003. These insiders can clearly see that, contrary to the claims of the bears, this bull market is still alive and hasn't breathed its last breath yet.

What I'd like to focus on right now is the irrational and relentless Equityphobia (fear of stocks) that multitudes of investors have been displaying since 2004. First let me say that I've never yet seen a significant stock market pullback or correction (like the one we've just seen) that didn't end with an overblown financial scare story. Near the bottom of the last major pullback in late February/early March the media was pounding the drums of a housing collapse and a sub-prime mortgage meltdown. We were told by the press that this crisis would soon spill over into all major sectors of the economy and that financial markets would melt, including a crash in the stock market. Did the stock market crash? Did the economy falter and the unemployment rate skyrocket? Did the housing market collapse even worse than it already had? The answer to each of these questions of course is "No!" What happened instead is that the stock market as measured by the S&P 500 found a strong level of support and took off from there to make an all-time high, traveling almost 200 points in the process.

This is how the media operate (on fear) and they make their money by telling people what they want to hear, which is always in line with the latest crisis of the hour. Perversely, it's also how many newsletter writers and investment strategists make a comfortable living. As Don Hays has said, "You produce crowds of adoring fans by giving nervous investors a good excuse for being nervous, and not by patting them on the back and telling them that this pain has been good for them and that they should be feeling fantastic."

There are a couple of things I've learned about the mainstream financial press over the years as it relates to the stock market. One is that you can always count on the press to spread fear and panic after a major market decline. There is currently no shortage of negatives the media can direct our attention to in order to get us worried: the oil price, the "credit crunch," the sub-prime meltdown and housing recession, the weak dollar, etc. The second thing I've learned is that you make the best investment decisions by going counter the "wisdom" of the mainstream press and doing the opposite of what they are saying. Today the message from them is loud and clear (reading between the lines): "Sell stocks, avoid exposure to equities, prepare for a recession!"

Add to that the latest credit crunch worries and we have all the ingredients for a continuation of the bull market with limited downside potential.



Clif Droke

Author: Clif Droke

Clif Droke

Clif Droke is a recognized authority on moving averages and internal momentum. He is the editor of the Momentum Strategies Report newsletter, published since 1997. He has also authored numerous books covering the fields of economics and financial market analysis. His latest book is Mastering Moving Averages. For more information visit

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