From the October 01, 2012 issue of Futures Magazine • Subscribe!

Sentiment: Putting trading into context

Seeing is not believing

In 2007, the Russell 2000 peaked in July while the rest of the market peaked in October. Around that time, real estate agents in Phoenix started noticing their deals weren’t closing so easily anymore. Suddenly, it was harder to put deals into escrow and the ones that went in weren’t making it across the finish line. By November the media picked up on the news and started discussing the slowdown, suggesting the economy would be coming in for a “soft landing” (see “Index sentiment gauge”). The Fed acknowledged a sub-prime problem but said the situation could be contained.

Why would the media predict a soft landing? The market was up for five years and with the easy money policies of the Fed, housing prices went through the roof. Prosperity seemingly returned; it didn’t matter if it was manufactured with smoke and mirrors. People were making money again and it’s difficult for individuals and the mass crowd collectively to envision conditions radically different over the next 12 months from the prior 12 months. Anyone who predicted a serious slowdown in the economy had his sanity questioned. The takeaway is this: In early stages of any new bear phase, look for headlines of denial or complacency regarding economic problems. It also is wise to be suspicious of those touting a paradigm shift. There were many voices warning of the impending bust cycle in housing and they, like equity bears in the late 1990s, were dismissed. When their arguments proved to be sound, those not prepared for the party to end pushed the “new paradigm” argument in both cycles. 

By the time 2008 rolled around, the economy wasn’t getting any better and market participants started waking up to the reality that no soft landing was in the cards. In fact, news started leaking out there were hundreds of thousands of resets on the books for late 2008, meaning many interest-only loans taken out over the past few years were close to expiration and subject to refinancing at higher rates.

By July 2008, Federal Reserve Chairman Ben Bernanke went to the Senate Banking Committee and, for the first time, the politicians held his feet to the fire because there was no soft landing nor was the housing crisis contained. This is what Elliott Wave analysts commonly refer to as the point of recognition. In terms of market sentiment, this is when psychology finally flips, the crowd realizes there is a problem and complacency turns into concern. The bottom line here is the bear phase had reached its analytical midpoint. 

The swelling concern developed into a crisis, and by September/October the market and economy had passed the point of no return.

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