You can probably relate: Every year, come January 1, I just can’t help but feel that “every little thing is gonna be all right,” as Bob Marley sang.

This year, the mainstream financial community is sharing the same sentiment. Here’s how EWI’s Steve Hochberg summarized it [emphasis added]:

At its conclusion, 2011 was marked by back-and-forth stock swings that resulted in essentially a flat market. My Bloomberg screen shows that the DJIA ended up 5.53% for the year, the S&P was flat…while the NASDAQ was down 1.80%. The broadest aggregate measure of stock market performance, the DJ Wilshire 5000, which includes nearly all stocks that trade, ended 2011 down 1%.

The Dow’s action masks a strongly negative stock market performance overseas. For instance, in U.S. dollar terms, the Euro Stoxx 50 Index was down nearly 20% in 2011, with the FTSE down almost 6%, the French CAC off almost 20% and the German DAX down over 17%. Asian markets were also hit hard. The S&P Asia 50 lost over 15%, the Nikkei declined 13%, the Hang Seng was off 20%, the Shanghai Composite ended 2011 down over 18%, while Australia was lower by 14%. All were down in euro terms, too.

But not to worry: a recent USA Today article notes that a “quick survey of New Year’s prognostications from investment strategists suggests stocks might deliver the double-digit gains that they have put up, on average, over the long term. A snapshot of 2012 year-end-price targets from five firms shows an average gain of 10.5% for stocks.”

Very optimistic, indeed!

Except, when have we heard that kind of talk before?

Hochberg continues:

The “10.5%” forecasted gains for the coming year is interesting because it is almost exactly the average forecasted gains for stocks for 2011, as the subheading in the following Barron’s cover story from December 2010 shows.

That’s right. A year ago, forecasts for stocks in 2011 were just as optimistic as they are now for 2012 — and largely for the same reasons: improving economy, recovering real estate and jobs markets, and a host of other “better fundamentals.”

From an Elliott wave perspective, the reason 2011 mainstream financial forecasts fell flat was simple: Stocks don’t follow the economy. It’s the other way around: The economy follows stocks.

What’s Really Ahead for 2012? There is a lot of optimism building around the stock market, but is it based on sound analysis or hope created by recent economic news reports? Elliott Wave International has released a free report to help you navigate the markets and prepare for what’s ahead. You’ll get hard facts, 25 eye-opening charts and 14 pages of straightforward commentary that will help you see the “big picture” so you can position yourself for the years to come.

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The following series is excerpted from two classic issues of Robert Prechter’s Elliott Wave Theorist. Although originally published in 2004, the valuable series has been re-released in the Independent Investor eBook, along with over 100 pages of other reports that challenge conventional economic thinking.

Here is Part IV of the series. Click these links to read Part I, Part II, and Part III. Or you can download your free copy of the Independent Investor eBook here.

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Another Example of Rationalization, Ripped from the Headlines Almost every day brings another example of rationalization in defense of the idea that news moves markets. The stock market rallied for half an hour on the morning of April 20, peaked at 10:00 a.m., and sold off for the rest of the day. Almost every newspaper and wire service claims that the market sold off because “Greenspan told Congress that the nation’s banking system is well prepared to deal with rising rates, which the market interpreted as a new signal the Fed will tighten its policy sooner rather than later.”³ Is this explanation plausible?

Point #1: Greenspan began speaking around 2:30, but the market had already peaked at 10:00.

Point #2: Greenspan said something favorable about the banking system, not unfavorable about rates. A caption in The Wall Street Journal reads, “Greenspan smiles, markets don’t.”⁴ The real story here is that the market went down despite his upbeat comments, not because of them.

Point #3: Greenspan’s speech was not the only news available. Most of the other news that day was good as well. As the AP reported, profits of corporations were good and “most economists don’t expect the Fed to raise rates at its next meeting.” So if news were causal, then on balance the market should have risen.

Point #4: The Fed’s interest rate changes lag the market’s interest rate changes. Interest rates had moved higher for months. Even if Greenspan had stated (which he didn’t) that the Fed would raise its Federal Funds rate immediately, it would have been no surprise.

Point #5: Greenspan said nothing that people didn’t already know, so while the fact of the speech was news, there was no news in the content of the speech.

Point #6: The simultaneously reported fact that “most economists don’t expect the Fed to raise rates at its next meeting” contradicts the argument for why investors sold stocks. If economists don’t believe it, why should we think that anyone else does?

Point #7: Greenspan did not say that rates would go up.

Point #8: We have no data on the history of stock market movement following mere hints of a possible rates rise, which means no data on which commentators could justifiably base an explanation of the market’s apparent reaction to such a hint, if in fact there was one.

Point #9: There is no evidence that a rise in interest rates makes the stock market go down. In 1992, the Federal Funds rate was 3 percent. In December 1999, it was 5.5 percent. The Dow didn’t go down during that time; it tripled. Rates also rose from the late 1940s to the late 1960s, during almost all of which time there was a huge bull market. Ned Davis Research has done the research and found that in the 22 instances of a single rate hike since 1917, “the Dow was always higher…whether three months, six months, one year or two years later.”⁵ In other words, if interest rates truly cause market movements, then a rate rise would be bullish. According to Davis, it takes a series of four to six rate increases to hurt the market, and that’s if you allow the supposed negative causality to appear up to twelve months later! So even accepting the bogus claim of causality would mean that investors would have had to read into Greenspan’s optimistic comment on the banking system a whole series of four to six rate rises, after which maybe the market would go down within a year after the final one! (The truth is that rising central-bank rates are usually a function of a strong economy, so many rate increases in a row simply mean that an economic expansion is aging, from which point a contraction eventually emerges naturally. Interest rates, like all other financial prices, are determined by the same society that determines stock prices. It’s all part of the flux within the same system. Changes in interest rates are not an external cause of stock price movements, just as stock price movements are not an external cause of changes in interest rates.)

So why did so many people conclude that Greenspan’s speech made the market go down? They didn’t conclude it from any applicable data; they just made it up. The range of errors required for people to concoct such “analysis” is immense, from an inapplicable chronology to contradictory facts to an utter lack of confirming data to a false underlying theory. Yet it happened; in fact, it happens every day.

Quiz: What does this sentence from the AP article mean? “Worries that interest rates will rise sooner rather than later have distracted investors from profit reports this earnings season.” Answer: It simply means, “The market went down today.” There is no other meaning in all those words.

The following series is excerpted from two classic issues of Robert Prechter’s Elliott Wave Theorist. Although originally published in 2004, the valuable series has been re-released in the Independent Investor eBook, along with over 100 pages of other reports that challenge conventional economic thinking.

Here is Part III of the series. You can read Part I and Part II here. Check back in a few days to read Part IV, or you can download your free copy of the Independent Investor eBook here.

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Cause and Effect In the 1990s, a university professor sold many books that made a case for buying “stocks for the long run.” In a recent issue of USA Today, he told a reporter, “Clearly, the risk of terror is the major reason why the markets have come down. We can’t quantify these risks; it’s not like flipping a coin and knowing your odds are 50-50 that an attack won’t occur.”¹

In other words, he accepts the physics paradigm of external cause and effect with respect to the stock market but says he cannot predict the cause part of the equation and therefore cannot predict stock prices. The first question is, well, if one cannot predict causes, then how can one write a book predicting effects, i.e., arguing that stocks will go up? Or down or sideways? A second question is far more important. We have already seen that economic performance, earnings and inflation do not necessarily coincide with movements in apparently related financial markets. In fact, the two sets of data can utterly oppose each other. Is there any evidence that dramatic news events that make headlines, such as terrorist attacks, political events, wars, crises or any such events are causal to stock market movement?

Suppose the devil were to offer you historic news a day in advance. He doesn’t even ask for your soul in exchange. He explains, “What’s more, you can hold a position for as little as a single trading day after the event or as long as you like.” It sounds foolproof, so you accept. His first offer: “The president will be assassinated tomorrow.” You can’t believe it. You and only you know it’s going to happen. The devil transports you back to November 22, 1963. You short the market. Do you make money?

Figure 5 shows the DJIA around the time when President John Kennedy was shot. First of all, can you tell by looking at the graph exactly when that event occurred? Maybe before that big drop on the left? Maybe at some other peak, causing a selloff?

The first arrow in Figure 6 shows the timing of the assassination. The market initially fell, but by the close of the next trading day, it was above where it was at the moment of the event, as you can see by the second arrow. You can’t cover your short sales until the following day’s up opening because the devil said that you could hold as briefly as one trading day after the event, but not less. You lose money.

You aren’t really angry because after all, the devil delivered on his promise. Your only error was to believe that a presidential assassination would dictate the course of stock prices. So you vow not to bet on things that aren’t directly related to finance. The devil pops up again, and you explain what you want. “I’ve got just the thing,” he says, and announces, “The biggest electrical blackout in the history of North America will occur tomorrow.” Wow. Billions of dollars of lost production. People stranded in subways and elevators. The last time a blackout occurred, there was a riot in New York and hundreds of millions of dollars’ worth of damage done. How more directly related to finance could you get? “Sold!” you cry. The devil transports you back to August 2003.

Figure 7 shows the DJIA around the time of the blackout. Does the history of stock prices make it evident when that event occurred? After all, if markets are action and reaction, then this economic loss should show up unmistakably, shouldn’t it? There are two big drops on the graph. Maybe it’s one of them.

The arrow in Figure 8 shows the timing of that event. Not only did the market fail to collapse, it gapped up the next morning! You sit all day with your short sales and cover the following day with another loss.

“Third time’s the charm,” says the devil. You reply, “Forget it. I don’t understand why the market isn’t reacting to these causes. Maybe these events you’re giving me just aren’t strong enough.” The devil leans into your ear and whispers, “Two bombs will be detonated in London, leveling landmark buildings and killing 3000 people. Another bomb planted at Parliament will misfire, merely blowing the side off the building. The terrorist perpetrators will vow to continue their attacks until England is wiped out.” He promises that you can sell short on the London Stock Exchange ten minutes before it happens and even offers to remove the one-day holding restriction. “Cover whenever you like,” he says. You agree. The devil then transports you to a parallel universe where London is New York and Parliament is the Pentagon. It’s September 11, 2001.

Figure 9 shows the DJIA around that time. Study it carefully. Can you find an anomaly on the graph? Is there an obvious time when the shocking events of “9/11″ show up? If markets reacted to “exogenous shocks,” as billiard balls do, there would be something obviously different on the graph at that time, wouldn’t there? But there isn’t.

Figure 10 shows the timing of the 9/11 terrorist attacks. You may recall that authorities closed the stock market for four trading days plus a weekend. Question: Was it a certainty that the market would re-open on the downside? No! Some popular radio talk-show hosts and administration officials advocated buying stocks on the opening just to “show ‘em.” You sit with your massive short position, and you are nervous. But you are also lucky. The market opens down, continuing a decline that had already been in force for 17 weeks. You cheer. You’re making money now! Well, you do for six days, anyway. Then the market leaps higher, and somewhere between one week and six months later you finally cover your shorts at a loss, disgusted and confused. If you are an everyday thoughtful person, you decide that events are irrelevant to markets and begin the long process of educating yourself on why markets move as they do. If you are a conventional economist, you don’t bother.

In case you still think that terrorism is a factor somewhere in the falling markets of 2000-2002, please read “Challenging the Conventional Assumption About the Presumed Sociological Effect of Terrorist News,” which is reprinted in Pioneering Studies in Socionomics. It shows unequivocally that the terrorist events and related fears of that time encompassed a period when the market mostly went up and consumer sentiment improved. The graph that accompanies that study is reproduced here as Figure 11.

Now think about this: In real life, you don’t get to know about dramatic events in advance. Investors who sold stocks upon hearing of the various events cited above did so because they believed that events cause changes in stock values. They all sold the low. I chose bad news for these exercises because it tends to be more dramatic, but the same irrelevance attaches to good news.

Since knowing dramatic events in advance would produce no value for investing, guessing events is an utter waste of time. There are no “inefficiencies” related to external causality that one may exploit.

If news is irrelevant to markets, how can the media explain almost every day’s market action by the news? Answer: There is a lot of news every day. Commentators don’t write their cause-and-effect stories before the session starts but after it ends. It’s no trick to fit news to the market after it’s closed. I am writing this paragraph the day after stocks had a big down day. The news at 8:30 a.m. yesterday was good, a “stronger-than-expected 1.8 percent jump in March retail sales.” How, then, did this morning’s newspaper, relying on cause and effect, explain yesterday’s big drop? (Remember, it’s easy to play games with cause and effect under the physics paradigm.) Here is the headline: “Rising-Rates Scenario Sends Stocks Reeling.”² This and other articles present the following ex-post-facto consensus reasoning: Investors appear to have decided that the good news that the economy is “starting to accelerate” might mean higher interest rates, which would be bearish if it happened. This contrived conclusion is doubly bizarre given the century-long history of interest-rate data, which (as the next section will show) belies such a belief. How, moreover, does one explain the fact that the stock market opened higher yesterday, in concert with the standard view of such news being “good”? There was no more big news that day. Had there been some “bad” news immediately after the opening, such inventive reasoning would not have been required. The “reason” for the rout would have been obvious, just as it was on the previous down day of this size, on which terrorists conveniently bombed trains in Spain. (Let me guess. You think that this example of news causality makes sense, don’t you? Sorry. Did I mention that the U.S. stock market — fully apprised of the news — rallied until noon that day before selling off?)

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Learn to Think Independently — Download Your Free Independent Investor eBook “The Stock Market is Not Physics” is just one report in the more than 100 page, two-volume Independent Investor eBook. You’ll get some of the most groundbreaking and eye-opening reports ever published in Elliott Wave International’s 30-year history; you’ll also get new analysis, forecasts and commentary to help you think independently in today’s tumultuous market. Download Your Free eBook Now.

The following series is excerpted from two classic issues of Robert Prechter’s Elliott Wave Theorist. Although originally published in 2004, the valuable series has been re-released in the Independent Investor eBook, along with over 100 pages of other reports that challenge conventional economic thinking.

Here is Part I of the series. Check back in a few days to read Part II, or you can download your free copy of the Independent Investor eBook here.

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See if you can answer these four questions:

1. In 1950, a good computer cost $1 million. In 1990, it cost $5000. Today it costs $1000. Question: What will a good computer cost 50 years from today?
2. Democracy as a form of government has been spreading for centuries. In the 1940s, Japan changed from an empire to a democracy. In the 1980s, the Russian Soviet system collapsed, and now the country holds multi-party elections. In the 1990s, China adopted free-market reforms. In March of this year, Iraq, a former dictatorship, celebrated a new democratic constitution. Question: Fifty years from today, will a larger or smaller percentage of the world’s population live under democracy?
3. In the decade from 1983 to 1993, there were ten months of recession in the U.S.; in the subsequent decade from 1993 to 2003, there were 8 months of recession. In the first period, expansion was underway 92 percent of the time; in the second period, it was 93 percent. Question: What percentage of the time will expansion take place during the decade from 2003 to 2013?
4. In 1970, Reserve Funds kicked off the hugely successful money market fund industry. In 1973, the CBOE introduced options on stocks. In 1977, Michael Milken invented junk bond financing, which became a major category of investment. In 1982, stock index futures and options on futures began to trade. In 1983, options on stock indexes became available. Keogh plans, IRAs and 401k’s have brought tax breaks to the investing public. The mutual fund industry, a small segment of the financial world in the late 1970s, has attracted the public’s invested wealth to the point that there are more mutual funds than there are NYSE stocks. Futures contracts on individual stocks have just begun trading. Question: Over the next 50 years, will the number and sophistication of financial services increase or decrease?

Observe that I asked you a microeconomic question, a political question, a macroeconomic question and a financial question.

Trend Extrapolation If you are like most people, you extrapolated your answers from the trends of previous data. You expect cheaper computers, more democracy, an economic expansion rate in the 90-95 percent range, and an increase in financial sophistication.

It appears sensible to answer such questions by extrapolation because people default to physics when predicting social trends. They think, “Momentum will remain constant unless acted on by an outside force.” This mode of thought is deeply embedded in our minds because it has tremendous evolutionary advantages. When Og threw a rock at Ugg back in the cave days, Ugg ducked. He ducked because his mind had inherited and/or learned the consequences of the Law of Conservation of Momentum. The rock would not veer off course because there was nothing between the two men to act upon it, and rocks do not have minds of their own. Earlier animals that incorporated responses to the laws of physics lived; those that didn’t died, and their genes were weeded out of the gene pool. The Law of Conservation of Momentum makes possible our modern technological world. People rely on it every day. Despite its use in so many areas, however, it is inapplicable to predicting social change. For most people in most circumstances, the proper answer to each of the above questions is, “I don?t know.” (Socionomics can give you an edge in social prediction, but that’s another story.)

The most certain aspect of social history is dramatic change. To get a feel for how useless — even counterproductive — extrapolation can be in social forecasting, consider these questions:

1. It is 1886. Project the American railroad industry.
2. It is 1970. Project the future of China.
3. It is 1963. Project the cost of medical care in the U.S.
4. It is 1969. Project the U.S. space program.
5. It is 100 A.D. Project the future of Roman civilization.

In 1886, you would have envisioned a future landscape combed with rail lines connecting every city, town and neighborhood. Small trains would roll around to your home to pick you up, and a network of rail lines would help deliver you to your destination efficiently and cheaply. Super-fast trains would make cross-country runs. You could eat, read or sleep along the way.

Is that what happened? Would anyone have predicted, indeed did anyone predict, that trains in 2004 would often be going slower than they did in 1886, that they would routinely jump the tracks, that they would be inefficient, that they would have little food and few sleeper cars, that the equipment would be old and worn out?

Did European Union leaders make the sovereign debt crisis “go away” last week?

Not even close. What they did agree on is tougher budget rules:

“…17 countries of the euro zone…agreed to run only minimal budget deficits in the future and allowed the European Court of Justice the right to strike down national laws that don’t enforce such discipline properly…”
Wall Street Journal, (12/9)

Will the EU agreement prove bullish or bearish for world stock markets, including the Dow Industrials?

Let’s put it this way: The evidence suggests that government intervention in the economy does not alter the dominant trend of financial markets.

For example: Look at the DJIA chart and try to identify when the U.S. government bailed out Fannie Mae, Freddie Mac, and other financial institutions.

“[The chart below] shows that in fact these actions took place in the early portion of the biggest stock market decline in 76 years. These actions did not push stock prices back up. The market finally bottomed months later, at a time when nothing along these lines happened.

“It is no good to claim that these actions had results eventually. By that reasoning, any future turn in the stock market would prove the contention.”
Elliott Wave Theorist, March 2010

If anything, the face value of this chart argues that economic government intervention makes stocks go down.

There is simply no “cause and effect” relationship between government actions and stock market trends.

The stock market’s price pattern is governed by the Wave Principle:

“Sometimes the market appears to reflect outside conditions and events, but at other times it is entirely detached from what most people assume are causal conditions. The reason is that the market has a law of its own. It is not propelled by the external causality to which one becomes accustomed in the everyday experiences of life.

“….The market’s progression unfolds in waves. Waves are patterns of directional movement.”
Elliott Wave Principle, (p. 21)

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Here’s why you SHOULDN’T get too comfortable

Bear markets are cunning beasts.

Don’t get me wrong — we are not in the bear market territory yet. At least, not officially.

An “official” bear market begins when the stocks indexes decline 20%. The DJIA’s decline from the May 2, 2011 high to the September 21 low is about 17%. Close, but no cigar.

Add to that the strong rallies we’ve seen over the past few weeks (Sept. 12-20: +685 points in the Dow, for example) — and lots of people conclude that despite the volatility, things aren’t so bad.

But let’s get some perspective. The stock market has been around a while. Only when you look at its history do you realize just how cunning — and fast, and strong — bear markets can be.

Here’s a chart we’ve shown readers before. It’s worth printing out and keeping on the wall above the desk where you open your brokerage statements.

This is the DJIA between 1930 and 1932, one of the worst bear markets in history. Robert Prechter, EWI’s president, took the time to measure the percentage gain of each bear market rally during the 2-year period — you can see them in this chart.

When you routinely see double-digit rallies (11 percent, 18 percent, even 39%) over the course of two or three years, it’s easy to be lulled into thinking that maybe things aren’t so bad.

The reality, of course, is that the bear market’s chokehold grows tighter around your neck with every drop-rally sequence. (Think back to the 2007-2009 collapse, and you’ll remember the same behavior.)

Which brings us to here and now. Rallies and declines of 300-400+ points have been so common since August that we’re kinda getting used to them.

The question is: Are we in a bear market, or is it that “maybe things aren’t so bad”?

You need some perspective to answer that question. The research we do here at EWI can help.

Free Report: Stocks — Buying Opportunity or Another “Free Fall” Ahead? Find out what these market moves mean to your investments with current analysis from Elliott Wave International. Bob Prechter has just released a FREE report — with urgent analysis from his August and September 2011 Elliott Wave Theorist market letters, including another video excerpt from the special video issue of the August Theorist. Stocks — Buying Opportunity or Another “Free Fall” Ahead? will help you put these uncertain markets into perspective so that you’ll be better positioned to both protect your investments when needed and prosper when opportunities arise. Access your free report now>>

Are you prepared for when the “disconnect” between the market and economy reconnects?

Suppose you see a lovely house — one with great curb appeal. It has new paint and manicured shrubbery out front.

But also suppose that you look more closely. You press your thumb on the window sill and the wood frame crumbles in. Come to find out, the wood is rotten in too many places to count. The deck joists and supports are fractured. Even the terrain underneath the deck looks unstable. And the closer you look the worse the problems are.

It’s obvious that very few people would buy that house. Yet you can be pretty sure that the home’s owner will have “good things” to say about the place.

Likewise, today’s stock market has plenty of cheerleaders — even as the rot spreads throughout the economy. Real estate and homebuilding sector alike continue to decline in the wake of the mortgage meltdown. Municipalities continue to have growing budget problems. We’re not talking about a “small town” bankruptcy, either. An Oct. 12 Reuters headline reads:

“Harrisburg, Pa., Files for Bankruptcy Protection.” The story goes on to say that “The Pennsylvania state capital faces a $300 million debt crises…”

This Oct. 12 headline is from Bloomberg: “California Kids Face Days Without School as Revenue Gap Imperils Education.” It continues: “Public schools in California…are bracing for a $1.7 billion cut that may wipe out high-school sports and student busing, and trim the academic calendar by seven days next year.”

The economic problems run much deeper and wider than these stories can reflect — yet they are indeed today’s stories. The capital of one of our biggest states is filing for bankruptcy? That should serve as an alarm. Then again, the market is rallying just weeks after the downgrade of U.S. Treasury debt.

So when will optimistic financial investors wake-up to reality?

“At some point in the trend toward negative social mood, fear, and then panic, will bring to light the risks that people today are ignoring. Global credit deterioration is objectively real; but disaster will strike only when it becomes subjectively realized.”
Elliott Wave Theorist, September 2011

Collective psychology could “catch up” to the objective economic reality sooner than later.

Will you be prepared when the economic reality hits?Robert Prechter has just released a FREE report — with urgent analysis from his August and September 2011 Elliott Wave Theorist letters, including an excerpt from a special video presentation that he created for his subscribers in August. Stocks — Buying Opportunity or Another “Free Fall” Ahead? will help you put these uncertain markets into perspective so that you’ll be better positioned to both protect your investments when needed and prosper when opportunities arise. Access your free report now >>

The attached table shows the performance of the Dow over the last 10 years by season.

Note that the summer months Q3 (July- September) are the worst performing months with 6 out of 10 years being down and only 2 out of 10 being up.

Q4 is historically the best performing months with 8 up years and no down years.

Q1 is more up than down and Q2 is about even with 3 down years and 4 up years.

Quarter	Number of Down Years	Number of Flat Years	Number of Up Years
Q1 Jan-Mar	2	4	4
Q2 Apr- Jun	3	3	4
Q3 Jul-Sep	6	2	2
Q4 Oct-Dec	0	2	8

What do you think of when you hear the phrase stock market correction?

If the major media is to be believed, a stock market correction is akin to Armageddon.  The sky is falling, etc, etc.

Truth be told,  stock market geniuses like Billionaire Warren Buffett see corrections as a fabulous thing.   It’s the flip side of a rally, nothing more, nothing less. In theory, corrections adjust equity prices to their actual value or “support levels”. In reality, it is much simpler than that. Prices fall when the market runs out of buyers. If you have cash you can pick up all kinds of bargains. Buffett hoarded his cash as the market got pricey because he said, he couldn’t find anything of value to purchase. In other words he knew the market was overpriced and so he hoarded his cash waiting for prices to come down… as he knew they would.

Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.  Warren Buffett

Here’s a list of 8 things to do during a stock market correction.

Study the past:

Corrections always lead to buying opportunities, so begin collecting a diverse group of high quality, dividend paying, NYSE companies when their prices drop. You will never be able to buy consistently at the bottom and sell at the exact top. So stop trying. Good traders are happy to get into a trade within 20% of the bottom and get out within 20% of the top. Long term investors like Buffet don’t even try to do that.

Our favorite holding period is forever. Warren Buffett

Buy Quality:

If you are buying quality equities for the long run as Buffett does, minor (or even major) downturns are simply opportunities to buy at a discount. This philosophy has served him well. Peter Doyle once said,  “Berkshire Hathaway sits on $45 billion of cash and generates about $5.2 billion of cash flow annually, … Berkshire and Warren Buffett have really become the lender of last resort or the buyer of last resort of many assets. And I think he’s going to pick up great assets at very distressed prices going forward.”

Focus On Your Long-Term Objectives.

Almost three years ago, Buffett offered GE cash when they needed it most and the terms were in Buffett’s favor. Now GE is looking to close out the deal later this year so they don’t have to continue to pay 10% a year to Buffett’s Berkshire Hathaway(BRK.A). By the time they close, the preferred GE shares will have earned Buffett $900 million in dividends. But he also received warrants giving him the right to buy $3 billion in additional stock at $22.25 before October 2013.  GE stock is currently trading at around $15.50 well below the value on the day Buffett struck his deal. So is he worried?

He once said he,

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

So he focuses on the long term. The question on this trade is whether he gave himself enough time. Will the price of GE stock rise above $22.25 within the next 2+ years? Interestingly in the six months after Buffett inked this deal GE stock fell an additional 75%  and hit an 18-year low below $6 before rebounding to current levels.

Don’t Buy on Emotion

Hope for a short decline, but prepare for a long one. There’s more to this strategy than meets the eye, most of us don’t have $45 billion sitting around like Buffet so you don’t wish to run out of money prior to the beginning of a new rally. If Buffett had been subject to emotion he may have second guessed his GE deal as he watched prices decline for six more months after he bought but he held fast.

“What people do is let their emotions get the best of them when they buy and sell. People often make the mistake of buying stocks only after they go up and not when they are bargains. There is a quote from Warren Buffett that Americans like to buy everything on sale except stocks.” Pat Dorsey

Continually examine the performance of your portfolio and watch your capital.

Keep in mind that corrections (of all kinds) will vary in depth and duration.

They don’t turn out to be obvious until long after the fact. The short and deep ones are the best buying opportunities; the long and slow ones are uglier and tend to grind investors to dust.

Be Decisive:

Unlike many points in life, Stock Market realities need to be dealt with rapidly, decisively, and with zero regret. Take the action you need to take based on the facts at hand. Simply remember: there has never been a correction that has not succumbed to the next rally or a rally that has not succumbed to a correction.

Value, Value, Value:

Price is what you pay. Value is what you get.  Buffett

Carpe Diem- Seize the Day

Corrections should be seen as opportunities to buy at a discount such as Buffett’s  $3 Billion GE investment. And more recently when he offered $5 Billion to bail out Bank of America (BAC) after they had to pay an $8.5 billion settlement with major holders of soured mortgage from Countrywide. On a less grand scale, recently Isaac Dabah former CEO of  Gloria Vanderbilt Apparel Corp. and current CEO of Delta Galil corporation, took advantage of the market situation and purchased the assets of KN Karen Neuburger® sleepware.  Delta Galil corporation markets  Tommy Hilfiger® and Lucky® intimates and is a good match for Neuburger which was often featured as one of Oprah’s “favorite things”. Dabah, said, “I’m a huge fan of the brand and I’m confident in its continued success with Delta Galil. Using our strength in fabric innovation, marketing and distribution, Delta intends to expand the Karen Neuberger brand on a global scale.”

So if like them, you have preserved your capital during the correction, once bargains appear, you will will be positioned to “seize the day”.

Best of Luck.

 

 

The typical financial disclaimer reads, “the past is no predictor of the future” but learning from historical markets is definately a good thing to do. For some time now Robert Prechter has been telling us to expect a double dip with 2008 being the first wave down. Today we are going to look to Chris Ciovacco, Chief Investment Officer of Ciovacco Capital Management. Typically Chris is a bit more upbeat than Prechter, lets see what he has to say as he compares current market conditions to 2000 and 2008.  ~ Tim McMahon, editor

Parallels To 2000 And 2008 Should Not Be Ignored

The current chart of the S&P 500 looks a lot like the U.S. Financial Index did in July 2008. You can blame speculators and computerized trading for the recent vertical plunge, but the speculators and trading algorithms properly identified serious structural problems with banks and mortgages in 2008. Have you ever seen speculators successfully attack a sound company? Almost without exception, when markets focus on a company in a negative manner, something is fundamentally wrong with that company. Enron stock began to drop well before the fraud came to light.

For those of you that feel government debt problems cannot derail strong companies like Coke and Apple (‘my stocks will be fine’), this video reviews parallels between the mortgage/housing crisis and the current debt crisis. While iPads are great, no stock may be immune to the selling if our leaders cannot plug the holes in the debt-crisis deck. The ship is still floating so there is some hope for bullish outcomes, but we are taking on water fast.

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Recent comments relative to the newly formed debt committee do not give us much confidence that they “get it” in our nation’s capital, even after recent events. Bloomberg reported the less than co-operative tone is unlikely to change between the two major political parties in the United States – markets want to see some unity and leadership, not this stuff:

Grover Norquist, president of Americans for Tax Reform, an anti-tax group, said the Republican negotiating team will serve as an effective roadblock to tax increases. “Taxes are off the table for this super-committee even more than they were when Boehner and Mitch McConnell” were negotiating with the president for a long-term debt agreement, Norquist said. “We’re now going to focus on spending cuts, and if the Democrats can’t do that, we’ll have the automatic cuts.”

We follow the 223 most liquid ETFs using the CCM Asset Allocation Model. We recently reviewed all 223 in detail. The list of ETFs includes stocks, bonds, commodities, and precious metals. While it has not fully given a “buy” signal, the best stock chart of the bunch is the Short S&P 500 ETF (SH), which is another reason to have bear market contingency plans within an arm’s reach.

If you are reading this analysis when the S&P 500 is experiencing a monster rally, keep the three historical rallies below in the back of your mind:

The three rallies above occurred in the context of a bear market. If the current market can rally and the S&P 500’s 200-day moving average can turn back up, then we would be more willing to push our bear market concerns aside. But a rally that occurs with a downward sloping 200-day moving average, even a big rally, should be viewed with a dose of skepticism.

The charts of the three rallies above illustrate two more points about bear markets:

1. Volatility picks up
2. Sharp rallies are common

We want to emphasize that it is not all gloom and doom. If leaders step up and lead on debt issues, markets could experience a monster rally, similar to what happened after sharp declines in 1994 and 1998. Our two primary market models remain in bull market territory, but they are hanging by a thread. The CCM Bull Market Sustainability Index (BMSI) closed at 215 on August 10. The historical risk-reward profile remains positive, but we are on the cusp of slipping into bear market territory. The BMSI tells us to be cautious, but in a manner that leaves the door open to better than expected outcomes.

The CCM 80-20 Correction Index also sits in a range still associated with bull markets. However, unfavorable risk-reward ratios will surface if stocks cannot gain traction soon. The 80-20 Correction Index closed at 516 on August 10, 2011.

The ADX indicator at the top of the weekly S&P 500 chart below measures the strength of a trend. The last time the red ADX line hit a level as high as the recent level was in 2008 (compare points A and B). Notice the negative outcome in stocks after point A. The black ADX line also sat at low levels in 2008, just as it does today. Not the end of the world, but it is another feather in the bear’s cap relative to the intermediate-term outlook.

The thin blue line in the chart above is the 200-week moving average, which sits at 1,155. A weekly close over 1,155 would be a good step for the bulls. Notice how the 200-week has acted as both support and resistance (green, red, and orange arrows).

Copyright © 2010 Ciovacco Capital Management, LLC. All Rights Reserved. Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC (CCM). .Terms of Use. This article contains the current opinions of the author but not necessarily those of CCM. The opinions are subject to change without notice. This article is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The charts and comments are not recommendations to buy or sell any security. Market sectors and related ETFs are selected based on his opinion as to their importance in providing the viewer a comprehensive summary of market conditions for the featured period. Chart annotations are not predictive of any future market action rather they only demonstrate the opinion of the author as to a range of possibilities going forward. All material presented herein is believed to be reliable but we cannot attest to its accuracy. The information contained herein (including historical prices or values) has been obtained from sources that Ciovacco Capital Management (CCM) considers to be reliable; however, CCM makes no representation as to, or accepts any responsibility or liability for, the accuracy or completeness of the information contained herein or any decision made or action taken by you or any third party in reliance upon the data. Some results are derived using historical estimations from available data. Investment recommendations may change and readers are urged to check with tax and investment advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. CCM would like to thank StockCharts.com for helping Short Takes create great looking charts