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Adam Hamilton: Cyclical Bear Market Rally Ahead

I tune in to Adam Hamilton once in a while just because his analysis is in-depth and provides the form of data modeling that i can never do.

This week he analyzes the stock market volatility that we have been experiencing for 4 months and how it measures up.

This picture gives you a good idea just in case you were too busy during this 4 months to realise the carnage that has swept the financial markets.

Stock Market volatility

Stock Market volatility

Adam seems to think based on all these, we should be expecting a big bear market rally:

Encouragingly, fear is abating as represented by the VXO. At its current pace of decline, it won’t be long until it falls under 50 again and this panic ends. We humans are remarkably adaptable. Put us in a bad situation, no matter how unpleasant, and it doesn’t take us long to adapt to it. Market conditions that terrified traders in early October have now grown kind of routine. We are all growing numb to extreme volatility, which really undermines fear. And once fear starts evaporating rapidly, this panic is over.

And since panics drive stock prices to irrational and unsustainable lows, when this panic ends we are likely to see a monster rally. It may just be a mighty bear rally, but it may also prove to be a new cyclical stock bull within this secular bear. I suspect the latter, given the ridiculous levels of fear this panic generated. And if this proves to be the case, now is a great time to add heavy long exposure in beaten-down stocks. My favorite sector in which to ride this coming rally is the incredibly oversold commodities stocks.

An interesting note he made is how difficult it is to launch trades to short the market when you know the direction is down:

There are a couple primary applications. First, as I discussed earlier, no one has ever seen anything like this event before. And even if you were bearish and short, as I was between January and early October, the hyper-volatility made it nearly impossible to launch profitable trades in recent months. Nothing works in such extreme choppiness.

[Read the full article here >>]


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Sunday 14th of December 2008

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