Are investors under a spell?

I have just read a fascinating article about Joseph Goebbels’ personal secretary (Frau Pomsel) and her life at the very heart of the Nazi regime. She was in Hitler’s bunker in 1945 when both Hitler and Goebbels committed suicide as the Russians knocked on their door.  She is now 103 and apparently as sharp as a pin.

But what struck me was her statement: “The whole country was as if under a kind of spell (in the Third Reich)”.  What a revealing sentence.

How else can you explain the fact that the German people – historically a very cultured and creative people (think Bach, Beethoven, Brahms) – could accept the sheer depredations and atrocities that went on under their noses for years?  Could you imagine such a thing happening in Germany today?  Of course not, yet the nation is mostly populated with the same Germanic stock as in the 1920s – 1940s.  So what is different between now and then?

Could it be that the people then were under a spell, as Frau Pomsel avers?

And could a similar spell-like phenomenon in finance explain the mania for shares (and many other assets) that has built up largely since WWII?  Have investors been cast a spell that impels them to buy assets and shun cash?

Of course, Charles Mackay wrote the definitive book on this subject back in the Victorian era – “Extraordinary Popular Delusions and the Madness of Crowds“.  And we are all familiar with some of the most notorious manias, such as the South Sea Bubble and the Tulipomania in 17th Century Holland.  We laugh at them now and poke fun at the suckers who fell for these massive delusions, but if you were living at the time it would be an unusual person who did not see the merits of a beautiful tulip – and its wealth-creating potential!

Indeed, seeing the quotes for the rarest bulbs rise sharply day after day, who would not have jumped on board sensing a terrific opportunity?  Suddenly, tulip bulbs are seen to have terrific intrinsic value whereas before, they were just bulbs to plant in the ground. But their friends were making big money, and this has always been an irresistible incentive to participate (and take leave of their senses!)

These tulip speculators must be some of the first ‘momentum’ players.  Of course, we have then today in the form of hedge funds, who are mostly trend-followers.  Some things never change – especially human nature.

Of course, market professionals must trade and be almost fully invested in what is going up and shun what is going down.  That is a major force in the markets – and hands us savvy traders a wealth of opportunities.  This impulse to buy only what is going up exactly mirrors the tulip bulb speculators.

Of course they dress up their buying decisions with sophisticated mathematical analysis and reading the tea leaves left by the various central bank characters.

So can we say that hedge funds (and private investors) are under a long spell?  After all, this is another name for herding, which I often cover.  And this herding is demonstrated by the COT data and sentiment measures such as DSI that I often quote.

In fact, latest DSI readings now show bullish S&P sentiment on a 10-day MA basis is around the 85% level – the highest level for over two years. That is herding par excellence.

We know that major highs are always made when bullish sentiment is elevated and that points to a coming high in stocks.

VIX – the Fear Index – has just made a new low at 11, and that is a record high in complacency and lack of fear of a decline.

The previous low at the 13 support level has been broken but note the strong MACD divergence at the 11 low – an indication that the impulse to buy stocks/sell fear is weakening.  It will not take much to turn this around.

We remain in the dog days of summer but the US Labor Day (on September 5) usually kicks off the trading season in earnest and I predict that we shall see activity pick up greatly with bigger swings.

Incidentally, on the subject of the huge inflation in share values over many years, here is another example of inflation – atomic research (a subject I have some familiarity with).

I just came across this picture taken in 1917 of the famous New Zealand physicist Ernest Rutherford who is credited with being the first to experimentally verify the atomic model of light electrons orbiting around a heavy nucleus.  Just admire the complex apparatus he worked with (remember, this was cutting edge science pre-WWI):

It looks like he went to the scrap yard to make it!  I doubt that it cost more than a hundred pounds.

Now fast forward to today’s cutting edge atomic science most notably at CERN in Switzerland (where the Higgs boson was apparently detected in 2012).

A slight difference, eh?  I’ll bet they didn’t get that in the junk yard!

The CERN annual budget is 1.2 Billion CHF and hosts over 10,000 staff.  (Rutherford worked on his own with the help of lab technicians to build the apparatus.) But CERN’s scientific achievements have been meagre to say the least – and nothing close to Rutherford’s contribution.  As a party trick, they have created anti-hydrogen atoms, though.

This is a vivid lesson in the law of diminishing returns, of course.  This law  is especially valid in science today.

Now, I don’t want to knock CERN (although I easily could) since it is the birthplace of the World Wide Web and without that, we would all be lost.

Crude oil powers ahead

I have written recently on my exploits in this market as it is today’s Duracell market.

But I want to show you what a short squeeze looks like:

Just when hedge funds had loaded up on the short side last month, convinced that with record stocks and high production, the market was headed much lower.  But as it hit the Fibonacci level of $40 on 2 August (which was our entry point), the market turned tail and the short squeeze on the hedgies was on.  As you know, this is one of my favourite scenarios.

The slight dip on 10 August was another opportunity to go long again and the market quickly ran up to my upper tramline.  At that point, I was unsure whether we had a budding five up or a corrective A-B-C.

In fact, I emailed VIP Traders Club members with my view that if the market turned down from the $45 level on the tramline, the A-B-C format was likely. But if the market broke through and made it to the $47 level, we are likely to have a five up.  And that level has been reached this week.

Here is a close-up

I have a nice clean break of upper blue tramline, and wave 2 is regulation three down. But momentum is waning, warning of a likely pull-back at some point.  Also, market is entering substantial overhead congestion on the daily chart and it is rare for a market to plough through solid resistance as if it was not there.

Odds now favour a pull-back to kiss the tramline, but market could have one more push up first.

If you wish to take part in these trading campaigns, I refer you to my website page on The VIP Traders Club.  It explains how the Club works in detail.