Trying to figure it all out

When I look at what's happening today it makes me wonder if there was ever a time when we saw something similar in the past. If we're indeed heading into a recession we have to assume that there's still significant downside to the market. If this happens it would be the first time in a long, long time that a new recession and bear market had begun when consumer confidence and the mood in general was still one of pessimism at the peak of a bull market. Was there ever a past precedent? I didn't think there was but perhaps I'm wrong. The best historical similarity could be the recession and bear market of 1937-1938. Prior to it, the market had been enjoying a  powerful cyclical bull market from the depths of the 1929-1932 collapse. During this recovery, profits had recovered back to pre-depression levels much like what has happened now. However, unemployment was still quite high dropping moderately from the depression peak of  25% to 15% before the  market peaked and the recession of 1937-1938 began which was accompanied by a drop of about 47% in the Dow before hitting bottom.

With 15% unemployment at the market peak in 1937, I would speculate that there was probably still a general sense of pessimism from main street. Could the same turn of events be happening again? Well, history doesn't repeat but it can rhyme. The main culprit for the 1937-38 recession was arguable but it coincided with significant spending cuts in the US to balance the budget and an increase in bank reserve requirements. Fast forward to today and we have the entire world embracing government austerity. It's argued by many that back then the government had pulled the economy off life support too early and as a result the economy went sick again as it had not fully recovered from the damage done by the 1929-1932 collapse.

Whatever the real reason for the downturn of 1937-1938 what it proves is that it may be indeed possible to see a recession and big bear market when the public was still feeling sour just prior to it....I say maybe because we didn't have hard data like consumer confidence numbers to verify this and so I used the high unemployment rate at the time as a proxy. Why did contrarian analysis fail? Well, first of all, contrarian theory offers no guarantees, it just gives you an edge just like how being dealt pocket aces gives you an edge but no guarantee you will win....sometimes you have to fold aces to make the correct play. Secondly, contrarian analysis suggested there was potential for further advances since there was still plenty of pessimism to unwind, but that potential went unfulfilled because of policy errors and/or an underlying economy that was still sick and fragile.

Here's what the 1937-38 bear looked like

Notice that this bear market did most of the damage in a straight line down fashion without any significant bear market rallies. It was basically 3.5 months of destruction, a brief respite and then a final leg down. It was a short but very painful bear. Do not rule out something like this happening. No two historical charts are alike so forget about thinking that a tit for tat reply of 1937-1938 will happen...all I'm saying is that when the fundamental tide turns for the worse and one thing goes wrong after another you can see a sickening slide in the market that catches even the bears off guard. That's what happened in the fall of 2008 as well.

What about the motto of this blog? At this point how would the market make fools of as many people as possible? There's two ways. 1) The market makes a LT bottom around current levels, we avoid a global recession (or it's very minor) and everything goes right in Europe or 2) the market just keeps sliding and sliding like in 1937-38 and we get no "4th quarter rally" that people are starting to chatter about while bears don't really make nearly as much as they should have as they cover shorts far too early, not making up for the losses they sustained over the past 2 years shorting the market in vain.

Whatever the case may be, I for one am not going to touch this market until I see a favorable risk/reward set up. I refuse to chase the short side with the market as compressed as it is even though I know we could very well go down a lot more and I'm not going to go long at a fresh 52 week low either especially when the fundamental tide has just turned for the worse only a few months ago, there's continued bickering in Washington and in Europe and there's unresolved issues that pose a major systematic shock if not handled correctly which let's face it, may very well not turn out to be the case given all the clownery (if there's such a word)  in Europe

It may turn out to be that I will remain mainly in cash for several months....who knows. If I don't like my starting hand I will fold it over and over and over for as long as it takes. I will not force trades nor will I play the intraday game of chicken with other traders. I don't give a rats ass if I miss the bottom or miss out on a continued crash. I've harvested nice profits over the past soon to be 3 years by being disciplined and patiently awaiting proper set ups and I'm not about to go squandering them chasing sub par set ups for the sake of trying to grow my account....I learned the hard way several years ago that this will backfire more often than not.

I'll end off by saying this....keep an open mind to the possibilities out there. It's easy to listen to the permabears when the market is bad and it's easy to listen to permabulls when the market is good. If all you do is listen to one or the other you will not see the market objectivity and get burned at major turning points from bull to bear markets or vice versa. I know for a fact tons of retail got burned worshiping the permabears over the past few years and now that the market has finally turned they don't have much money left to capitalize. I also realize that I've done a complete 180 turn from just a few months ago but that's what you have to do sometimes...you have to be willing to do a 180 turn from a long held belief in the market immediately if the evidence suggests so. Leave your pride and ego aside.