Is the Psychotic Stock Market a Replay of 2000-02?

by Gary Dorsch, Global Money Trends. January 31, 2008

Jesse Livermore, perhaps the greatest trader of all-time, used to say that "the stock market is designed to fool most of the people most of the time." That certainly seems true today, as the market's mental state resembles that of a psychotic, subject to radical mood swings, between extreme fear and euphoria. Yet the most important factor that a speculator must control is his emotions.

Livermore, who made $100 million shorting the stock market during the crash of 1929, always considered himself to be a student of the market until his last days. "The market must be studied and learned, not in a casual way, but in a deep knowledgeable way. Like no other entity, the stock market, with all its allure of easy money and fast action, induces people into the foolish mishandling of their money. The reverse of ignorance is knowledge, and knowledge is power," he said.

Livermore had a reputation as the "Boy Plunger" willing to go against the crowd as a contrarian, often on the short side of the market, and against the bullish bias of the media and the brokers.

But betting on the short side of the stock market today is a much tougher challenge. The US Treasury and the Federal Reserve have formed a close alliance to prevent a bear market on Wall Street from emerging at any and all costs.

The "Plunge Protection Team" wants to prevent a replay of the bear market of 2000-02, when the S&P 500 Index lost half of its value from its peak in March 2000, and ushered in an economic recession in 2002. Recessions in the US economy usually arrive about once every six years. Since the last recession ended in 2002, a downturn in the world's largest economy is probably due in 2008.

Until now, the biggest threat to US household spending was focused on the slumping housing market, but history suggests consumers can withstand one serious blow to their wealth. But a double-barreled assault can be disastrous, so if the stock market keeps sliding, it would probably tip the economy into recession. The US Treasury won't start sending out $150 billion of tax rebate checks until June.

The Bernanke Fed is ready to print the money to pay for the $150 billion stimulus package, and has already slashed the federal funds rate to 3%, the lowest since June 2005, in sync with the slide in the stock market and US home prices.

"Easy" Al Greenspan had one formula for rescue operations during times of financial distress. From the stock market crash of 1987, to the S&L crisis of the early 1990's, to the Asian crisis and the collapse of LTCM, to the feared Y2k crisis, to the bursting of the tech stock bubble, Greenspan responded with massive doses of monetary morphine to bailout over-zealous speculators in the stock market.

But the "Greenspan Put" ultimately failed to turn the bearish tide in S&P 500 Index for two years, until the US benchmark stock index made a triple bottom in Q–1 2003. Markets do not travel in straight lines, and the S&P 500's bear market included three horrific crashes, and a few powerful recoveries, aided by big Fed rate cuts and massive injections of monetary morphine.

But the market's attempt to rally from V-shaped spike bottoms ultimately fizzled out before suffering the next brutal slide into lower ground. It's difficult to stand on one foot for too long, or sustain a rally from a V-shaped bottom. From a technical point of view, a bull market is better off starting from a solid base, such as a "double or triple" bottom, since it’s easier to run with two or more legs.

The sharp slide in US Treasury 2-year yields from 5% in June to as low as 2.12% today, has already telegraphed a half-point Fed rate cut to 2.50% in March. The bearish "Head & Shoulders" Top pattern met its downside objective at the 11,500 level, ending in a climactic sell-off and a classic spike bottom. Expectations of a half-point Fed rate cut to 2.50% put a floor under the DJI-30 at the 12,000 level this week, inviting bargain hunters to bid for battered blue-chip stocks. After breaching resistance at the August spike bottom low at 12,550, the next upside resistance level is seen at the 12,750 level, the "neckline" of the H&S Top pattern.

Gary Dorsch

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