'A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.' - Winston Churchill
Does that mean that an optimist is always right? No. In fact, unfounded optimism is one of the biggest investment traps and most effective bear market tricks.
Parallels Between 2000, 2007, and Today
The parallels between the 2000, 2007 and forming 2010 tops were striking, that's why the newsletter concluded that: 'A comparison between the 2000 and 2007 double tops to the current constellations shows that the market may roll over at any time.'
Similar to the January/April 2000 and July/October 2007 double tops, the April 2010 highs were preceded by a lower January top. But the parallels didn't stop there.
Major Tops Followed by Decoy Rallies
Following the initial 2007 decline, the April, May 2008 rally rekindled new hope and pushed the major indexes a la Dow Jones (DJI: ^DJI), S&P (SNP: ^GSPC), and Nasdaq (Nasdaq: ^IXIC) briefly above their 200-day moving average (MA).
Following the initial April 2010 decline, the July/August rally also pushed the S&P briefly above the 200-day MA. Both, in 2008 and 2010, the indexes were rebuffed by the 200-day MA. The failure to stay above the 200-day MA in May 2008 was followed by a 53.75% decline in the S&P 500.
Like a free diver who comes up for air, the market tends to rally to keep investors engaged before the next leg down. The chart below - which plots bullish advisor sentiment against the price of the S&P 500 from June 2007 - September 2010, illustrates the market's cruel habit of spreading hope just before the hammer drops.
It Happened to an Entire Country
The Nikkei is Japan's version of the S&P 500 and covers hundreds of stocks. In 1989, the Nikkei topped at 38,946. Since then, it has dropped over 80% to below 8,000 (see chart below, published in the April 2010 ETF Profit Strategy Newsletter).
Throughout this 20-year decline, the Nikkei had eleven rallies of 20% or more and four that were 50% or more. In total, the Nikkei rallied well over 250,000 rally points, yet it remains 76% below its 1989 peak.
The decline of Japan's stock market (NYSEArca: EWJ - News) and economy happened amidst a global bull market. Imagine what can happen to the U.S. stock market during a global recession spurred by European (NYSEArca: FEZ - News) debt woes and global stock market (NYSEArca: EFA - News) weakness.
It's human nature to rationalize and invent reasons why something can't happen. It's the stock market's nature to prove investors wrong. Based on parallels that aren't farfetched by any means, a follow through of the post 2007 U.S. equity meltdown is more than just a possibility.
Fundamentals, Technicals, Valuations, and History in Agreement
Investing is about putting the odds in your favor. There is no such thing as a 100% certain profit opportunity. However, there are high probability profit opportunities where the odds of having a winning trade are high and the potential reward is much higher than the potential risk.
Such high probability profit opportunities occur when as many indicators as possible point in the same direction. Right now, there is a near unanimous consent between fundamental and technical indicators, along with valuations and historic patterns.
Even though the economic outlook is dim, realistic investors can feel optimistic about the opportunities in the months and years ahead.
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