Wednesday, April 22, 2009

The Mamis Bottom Formation

In his book The Nature of Risk, market thinker Justin Mamis looked at what bottoms look like and tied it to the sentiment cycle.

At bottoms, fundamental analysis fails and trader sentiment becomes more important. Humans are hard-wired to become fearful at an existential threat. Mamis sees Panic (Point A) as the ultimate manifestation of fear of impending doom, which gives way during a bear market to Discouragement (Point C).

The climb from Point C to Point D is called the Wall of Worry and is marked by a lack of fundamental backing to the rise in stock prices. All the news is bad and the global economic picture is dire, but the market rises dramatically regardless. Sound familiar? Nouriel Roubini recognizes this phenomenon has occurred and seems surprised that the market has rallied. This shows how clueless an economist in regards to the sentiment involved in trading.

Bear market rallies occur as day follows night. From 1929 to 1933, the last deflationary downturn, we had many double digit market rallies as the market dropped 84% of its value in 40 months.

In every bear market the bad news wears investors out and there is new belief in negatives. I think is coming soon.

In the current SPY, we can see similar patterns of Panic, Discouragement and now the Wall of Worry. Eventually there will be a renewed belief in negatives and my guess is that will come soon as the bank stress tests come out and the market rally tires. Aversion phase (Point E) will need to come and that will make a higher low than the March 9th mark.

After that only good news will instill the necessary belief in the market to move stock prices up. This is only one scenario, but it may be time to take some profit off the table and even look at some short opportunities. Also, we can look at sectors that perform in various stages of the recovery.


  1. Scares the crap out of me when you post a prediction... Cause it's been a good contrary indicator..... I don't mean to joke at your expense.... or mine.

    SO.... we think of the charts on different time frames... I would suggest we do the same thing with sentiment.

    Short term, Intermediate, Long term, maybe even on a Multi Decade Basis.

    I suspect this post is based on what I tried to explain the other day... and you have it roughly. But what you have seems more like an intermediate top, and not a short term top.

    Not saying you are wrong, Cause I like the short term sideways, but I'd say the limited downside here is going to be because of the massive short interest in the market.

    So Another model, would be to have an intermediate high in June, then the real Aversion phase happens

  2. So, in other words, you're thinking maybe Point D in June, then Aversion (or Point E) after that? I can buy that I guess, but I have a couple problems.

    1. Short interest is decreasing, albeit from higher levels, but it has plateaued and is now lower. If you have other info, I'd be interested.

    2. Mamis barometers of new-highs and new-lows are not bullish and have been bearish for a couple weeks.

    To me the risk reward favors caution from this point and maybe even an aversion phase sooner rather than later. The upside is maybe 3 points on SPY to 87, but the downside is 9 points to 74.50 or so. Risk management.

    Technically we are up against a lot of resistance as well. As a result of these concerns, I have now mixed shorts with longs and closed the more speculative plays and sold my financial stocks pending the news on the Stress tests in 10 days. This could be a sell the news scenario.

    So far, my shorts are outperforming my longs this week... oh yeah, and GLD and SLV are doing okay, too.

  3. Roughly the differences between our Theories, are "how Far will we pull back...

    Because I see a Short term top(which I think is Teresa's read too(I think), so we have to move through the Short term sentiment cycle.. to the down side...

    The argument at this point is if Monday was panic in that short term cycle and if we are working on discouragement.

    That Wedge Running triangle, has a 78 target on a running triangle(I think), or the wedge has a 76 target... if I'm reading it right (Both Numbers are Without my usual haircut for game theory)

  4. "As of March 31, short interest on the NYSE rose to about 16.181 billion shares, compared with 16.169 billion shares as of March 13."

    apparently it's been flat since... according to your story. I'm not sure if it gets published every week or 2? or just once a month..

  5. BTW, if I ever say "cautiously optimistic", feel free to put a bullet thru my temporal lobe.

    I like making predictions-- knowing full well that they will be off-- just to put my thoughts down and look a them later to see how far off I was.

  6. It's one thing to say something, another to "Think it", then of all the things we "Think" to then at some later date say I was Right... I thought that.

    but one realizes of the 10thousand things we "Thought" one of them was likley to be right.