Thursday, June 16, 2005

The Dog That Didn't Bark

One reason speculation is fun is that it involves a lot of detective work. My favorite sort of clue is “the dog that didn' t bark”. This is a situation in which the market doesn’t do what you think it should in response to news.

Since February 2004 the Dow and the Nasdaq composite have traded sideways while the S&P 500 has crept a little higher. During this 16month period the news has been terrible: Fed tightening, high oil prices, US dollar in the tank, fears of a housing bubble, weak employment growth, Iraq, Bush hatred.

It is easy to understand why people might sell stocks during this period. But who would be buying? Well, clearly the buyers are people who aren’t affected by the gloomiest efforts of the news media. These are investors with very long time horizons and they have been numerous enough to keep the market on an even keel despite all the bad news. The market has moved into “strong hands”, a very bullish situation. The only reason it has not rallied sharply is that the bad news has encouraged short term speculators to sell the news.

I think the news will turn more neutral or even bullish during the coming months. Short term speculators will then scramble to buy back the stocks they sold during the past 16 months when the news was bad. But they will have to bid the stock away from long term investors who bought when the news was bad. Stock prices will soar because these long term investors will part with their positions only at a big premium over their average price - about 1140 in the S&P and 10300 in the Dow.

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