The Psychology of A Triple Bottom

By Dr. Duru written for One-Twenty

June 29, 2008

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"Fool me once, shame on you. Fool me twice, shame on me." Fool me thrice, and I must really be asking for it.

In January, the S&P 500 put in a climactic bottom with the VIX spiking to 37.57. The Federal Reserve stepped in with a surprise 75 basis points interest rate cut. In March, the S&P 500 put in another climactic bottom with the VIX spiking to 35.60. The Federal Reserve once again came to the rescue by sweeping the Bear Stearns mess under the JP Morgan rug. The Fed added another rate cut for good measure. The S&P 500 is now dangling directly above a 52-week and multi-year closing low again, and everyone is wondering why the VIX is not spiking in tandem. It is now sitting at a relatively low 23.44.

What new government intervention could be possible to further prop up this weakening stock market? A potential answer may be in oil since that is the latest crisis that has everyone's focus. So many people refuse to believe oil is really worth $140+. So many people believe speculators are up to no good and single-handedly sending prices higher (note we loved it when speculators drove the prices of technology stocks and then our homes up to ridiculous levels). I have to believe that if oil gets smacked down, even 10%, hope for the economy and the stock market will re-appear.

Regardless of the catalyst, think about the psychology of the triple bottom this way... Some group of sellers panicked in January and sold only to see the market bounce higher. These same sellers chased the bounce with new buys and added to the new group of sellers who panicked in March and sold. All of these sellers now refuse to get fooled yet again. This time, they will hold for a bounce and will come up with any reason to hold out hope - typically this is where you hear the pundits on TV switching to long-term thinking to justify their promotion of stocks. I am no trained psychologist, but if I am correct about my views, then of course the level of fear will be lower than what we saw earlier this year (of course, a study of past triple bottom patterns would help as well). There is confidence in these levels as support. Selling here has left a lot of people feeling stupid. We should see a bounce, as early as this week, that gives these folks one more chance to get out before the 52-week lows break decisively. THAT break should get the VIX really going. In the meantime, it makes sense to load up on puts while they remain relatively "cheap."

On Thursday, Fast Money guest technician Carter Worth provided some convincing rationale for why we should expect the S&P 500 to ultimately break (he starts at 11:15 in the video). He reminded me how our two lows this year have been effectively engineered by government intervention (sometimes called the Plunge Protection Team by cynics and bears alike). Worth's target for the S&P 500 is around 1200 which is the same target I drew out back in March. Even though that target is "only" 6.5% away from current levels, do not expect us to get there in a straight line. In an earlier missive, I outlined the technical case for a peaking S&P 500 AND included a note pointing to oversold conditions. We have since become even more oversold, and the rubberband at these technical levels has a history of snapping back hard and viciously.

Be careful out there!

Full disclosure: Long S&P 500 in an index mutual fund. And, yes, I am not happy about it! For other disclaimers click here.

DR. DURU®, 2008