Technically Speaking: Christmas Cheer Or Excessive Exuberance?

It is this push higher in prices, as noted by Bob Farrell’s Rule #2 that is most important:

Excesses in one direction will lead to an opposite excess in the other direction.”

Markets that overshoot on the upside also overshoot on the downside, kind of like a pendulum. The further it swings to one side, the further it rebounds to the other side.

On a longer term basis markets adhere to Newton’s 3rd law of motion:

“For every action, there is an equal and opposite reaction.” 

The first chart shows that cyclical markets reach extremes when they are more than 2-standard deviations above, or below, their respective 50-wk moving average. While markets can trend higher in the near-term, there is ALWAYS a point where prices revert to the 50-week moving average or beyond.

(Click on image to enlarge)

The second chart shows price reversions of the S&P 500 on a long term basis. Notice that when prices have historically reached extremes – the reversion in price is just as extreme. This current extension above the long-term historical mean will likely end just as badly as they always have in the past.

(Click on image to enlarge)

As Bob Farrell also states:

“There are no new eras – excesses are never permanent.”

There will always be some “new thing” that elicits speculative interest.These “new things” throughout history, like the “Siren’s Song,” has led many investors to their demise. In fact, over the last 500 years, we have seen speculative bubbles involving everything from Tulip Bulbs to Railways, Real Estate to Technology, Emerging Markets (5 times) to Automobiles and Commodities.

It always starts the same, and ends with the utterings of “This time it is different”

Being a contrarian can be quite difficult at times as bullishness abounds. However, it is also the secret to limiting losses and achieving long-term investment success. As Howard Marks once stated:

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Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Streettalk Advisors, LLC expressly disclaims all liability in ...

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