The Art of Contrarian Trading Part 7

As I write these paragraphs I find it jarring to recall that the 1990-1991 recession had already officially ended in March 1991, seven months before this sequence of cover stories appeared. The U.S. unemployment rate was still rising, however, and would reach a high of 7.8 percent in June 1992. To put this into historical perspective, the highest post-World War II unemployment rate was 10.8 percent, reached in December 1982. The highest recorded unemployment rate during the Great Depression of the 1930s was 25 percent. Two points are worth making here. First, it is highly unlikely that any bullish information cascade will develop in the stock market while unemployment rates are rising during a recession or its immediate aftermath. Second, in this particular case one gets the impression from these magazine covers that the U.S. economy was on the verge of collapse into Depression-era conditions. This ill.u.s.trates the tendency of the media to exaggerate economic news, especially the worrisome kind, a tendency that helps start information cascades of one kind or the other. This tendency seems especially p.r.o.nounced when the president of the United States happens to belong to the Republican party.

This intense pace of pessimistic cover stories slowed significantly in 1992 but did not halt entirely. The October 24, 1992, issue of the Economist Economist showed a painting of s.h.i.+pwrecked sailors clinging to a rock in the ocean and was captioned: "Recession or Doom?" Remarkably, barely four months later and following the election of President Bill Clinton, a Democrat, the same magazine showed a cover cartoon of a joyful Uncle Sam springing up from his hospital bed, on which hung a chart of an upturn in economic activity. The cover caption read: "No Need for a Boost." showed a painting of s.h.i.+pwrecked sailors clinging to a rock in the ocean and was captioned: "Recession or Doom?" Remarkably, barely four months later and following the election of President Bill Clinton, a Democrat, the same magazine showed a cover cartoon of a joyful Uncle Sam springing up from his hospital bed, on which hung a chart of an upturn in economic activity. The cover caption read: "No Need for a Boost."

The magazine cover indicator was quiet for the rest of 1993. However, after a bearish information cascade that fairly can be said to have lasted nearly three years, the contrarian trader could rightly surmise that it would take at least a year and probably several before bullish animal spirits could revive and once more manifest themselves in the stock market. For this reason I think the conservative contrarian trader would have chosen to ignore any drop in the 200-day moving average of the S&P in 1994. In the event, this moving average did turn down but not by the full 1 percent required by the Contrarian Rebalancing strategy, so the issue was moot in any case.

THE STOCK MARKET BUBBLE INFLATES, 1995-2000.

The very first convincing sign that a bullish information cascade had begun appeared on the cover of the November 13, 1995, edition of U.S. News & World Report U.S. News & World Report. The cover caption read: "Gold Rush in Cybers.p.a.ce-The Internet Will Change Everything-And Everyone Wants a Piece of the Action." The boom in Internet-related stocks had begun, but, as usually happens, no one could imagine the heights of overvaluation that these bubble stocks would reach. Note that this cover should have attracted the attention of aggressive contrarian traders because it was evidence that the internet stock bandwagon had started rolling. Bandwagon investors in this and related sectors did very well during the subsequent five years.

On June 3, 1996, BusinessWeek BusinessWeek took note of the stock market upsurge with a cover captioned: "Our Love Affair with Stocks-Never before have so many people had so much riding on the market. Should we worry?" The September 30, 1996, cover of took note of the stock market upsurge with a cover captioned: "Our Love Affair with Stocks-Never before have so many people had so much riding on the market. Should we worry?" The September 30, 1996, cover of Time Time magazine showed a photograph of Ned Johnson, head of the mutual fund complex Fidelity Investments. Johnson is depicted holding a globe covered by ticker symbols. The cover caption read: "Can Fidelity Still Make Your Money Grow?" magazine showed a photograph of Ned Johnson, head of the mutual fund complex Fidelity Investments. Johnson is depicted holding a globe covered by ticker symbols. The cover caption read: "Can Fidelity Still Make Your Money Grow?"

This Time Time cover was definitive evidence that a bullish stock market crowd had formed. It demonstrated that the public mind was focused on the stock market, because cover was definitive evidence that a bullish stock market crowd had formed. It demonstrated that the public mind was focused on the stock market, because Time Time is a general interest newsweekly. But the critical thing every contrarian must remember is that it is very difficult to predict just how big any bullish crowd will eventually grow. In this particular case the crowd continued to grow until the end of 1999, a full three years after the appearance of this is a general interest newsweekly. But the critical thing every contrarian must remember is that it is very difficult to predict just how big any bullish crowd will eventually grow. In this particular case the crowd continued to grow until the end of 1999, a full three years after the appearance of this Time Time cover. The fact that the cover. The fact that the BusinessWeek BusinessWeek cover asked "Should we worry?" suggested to me that the bullish crowd would grow still bigger until worry was no longer a.s.sociated with the stock market. cover asked "Should we worry?" suggested to me that the bullish crowd would grow still bigger until worry was no longer a.s.sociated with the stock market.

Recall that the Contrarian Rebalancing strategy called for the conservative contrarian trader to reduce his stock market allocation to normal levels in early 1994. From that point forward he maintained that normal allocation. Even after he had recognized this Time Time cover as strong evidence of a mature bullish investment crowd, the contrarian trader would continue holding a normal stock market allocation. Any reduction in stock market exposure would have to await a turn downward in the 200-day moving average of the S&P by 1 percent or more. When the cover as strong evidence of a mature bullish investment crowd, the contrarian trader would continue holding a normal stock market allocation. Any reduction in stock market exposure would have to await a turn downward in the 200-day moving average of the S&P by 1 percent or more. When the Time Time cover came out, the S&P stood at 686. But the moving average sell signal did not occur until January 2, 2001, cover came out, the S&P stood at 686. But the moving average sell signal did not occur until January 2, 2001, more than four years later more than four years later. On the signal day the S&P closed at 1,283, 87 percent higher than on the date when that 1996 issue of Time Time hit the newsstands. hit the newsstands.

There was naturally much more evidence of this enormous bullish information cascade as it proceeded through 1997, 1998, and 1999. For one thing, stock market valuations as measured by dividend yields, price-earnings ratios, and Tobin's q ratio were literally off the chart. Even more telling were the frequent articles in the financial press explaining why traditional valuation measures were no longer useful in this new era bull market. The same kind of rationalizations appear to justify out-of-sight stock prices near the top of every extended boom and are always a sign of an inflated bubble and a mature stock market crowd.

Another interesting sign of the times could be found at your local bookstore. In sharp contrast to the situation in 1982, books about the stock market had become popular and were being published weekly. They occupied more and more retail shelf s.p.a.ce. Especially popular were those books that married computer technology to stock market trading. Typical were three books reviewed by Christopher Byron in the June 28, 1999, edition of the Wall Street Journal Wall Street Journal. Their t.i.tles: Day Trade Online Day Trade Online, How to Get Started in Electronic Day Trading How to Get Started in Electronic Day Trading, and Electronic Day Traders' Secrets Electronic Day Traders' Secrets.

The definitive history of the remarkable 1982-2000 bull market has yet to be written. As I mentioned in Chapter 5, I recommend that every contrarian trader read Bull! Bull! by Maggie Mahar. This book, published in 2004 by HarperCollins, does a fine job of recounting the history of the boom and bust from 1982 through 2002. by Maggie Mahar. This book, published in 2004 by HarperCollins, does a fine job of recounting the history of the boom and bust from 1982 through 2002.

The conservative contrarian trader did reasonably well during the historic advance of 1987-2000. He certainly beat buy-and-hold investors by maintaining an above-normal stock market allocation during most of the 1991-1994 advance. At that point his allocation reverted to normal and he continued holding a normal allocation until January 2, 2001. While these are not spectacular results, one should keep in mind that the 1987-2000 period was one during which the buy-and-hold strategy outperformed virtually every other imaginable portfolio strategy. Even worse, many self-styled contrarians hurt themselves badly by remaining out of the stock market from 1996 or 1997 onward. Indeed, those who heeded Robert s.h.i.+ller's 1996 warning (conveyed to the public by Alan Greenspan, chairman of the Federal Reserve) about the then-visible irrational exuberance irrational exuberance of the stock market vastly underperformed buy-and-hold investors from that point forward. It was certainly true that in 1996 that stock market values were historically high and that a bullish stock market crowd had formed. But it is equally important to remember that bubbles can inflate much further than can be imagined by reasonable people. Our Contrarian Rebalancing strategy's 200-day moving average tactic is designed to take this fact of financial life in a bubble into account. of the stock market vastly underperformed buy-and-hold investors from that point forward. It was certainly true that in 1996 that stock market values were historically high and that a bullish stock market crowd had formed. But it is equally important to remember that bubbles can inflate much further than can be imagined by reasonable people. Our Contrarian Rebalancing strategy's 200-day moving average tactic is designed to take this fact of financial life in a bubble into account.

THE AGGRESSIVE CONTRARIAN FACES THE 1987 CRASH.

In the rest of this chapter I am going to ill.u.s.trate the use of the aggressive contrarian stock market strategy, described in Chapter 11, at three dramatic junctures during the 1987-2000 bull market. This recounting of an aggressive contrarian's actions during this 14-year bull market is therefore far from exhaustive. The complete story would take more pages to tell than anyone would want to read. I'll be content to convey the essence of an aggressive contrarian's market approach by describing only a few of the more important portfolio adjustments made by the aggressive contrarian trader during this time.

As explained earlier in this chapter, the contrarian trader had every reason to believe that a bullish stock market crowd had formed by the summer of 1987. The stock market averages were clearly overvalued by historical standards of dividend yield and price-earnings ratios. Sentiment was optimistic and bullish, largely because the averages had risen substantially since 1982. For example, from August 1982 through June 1, 1987, the S&P 500 had risen about 24 percent per year.

In March 1987, with the S&P trading a little below the 300 level, I decided to reduce substantially my portfolio allocation to the stock market. At the time I was measuring the S&P's progress from its July 1984 low at 148. By mid-1986 the average had advanced 65 percent from that low over a period of about two years. This met the minimum standard for potential market overvaluation. However, in 1986 I did not yet see convincing evidence of a bullish stock market information cascade. Moreover, at the time I thought that the advance from the 1982 lows would take about five years before significant levels of overvaluation could be reached. So I maintained an aggressively bullish stance until March of the following year.

Note that in March 1987 I reduced my own exposure to the stock market to well below normal levels, a tactic I do not recommend even to the aggressive contrarian trader. But I was confident that even if the S&P moved substantially higher I would get a chance to increase my stock market exposure to above-normal levels within a few months. In the event, the high close for the S&P was 337, reached on August 25, 1987.

On Friday, October 16, the S&P closed at 282, a level 5 percent below its 200-day moving average and a signal to the aggressive contrarian trader that a bear market had started. No bearish information cascade was visible at the time, so the aggressive contrarian would want to reduce his stock market exposure to below-normal levels on this signal. Why? A bullish stock market crowd had clearly formed by the summer of 1987. When such crowds disintegrate, the averages typically drop a minimum of 30 percent from their highs and sometimes more. Such a prospect justifies having only a minimal exposure to the stock market.

The next trading day, October 19, 1987, the major averages dropped an astounding 20 percent. The S&P closed that day at 225. I remember the following day as a completely chaotic one in the markets. Around midday on the 20th, there was effectively a trading halt on the New York Stock Exchange. There were no bids for stocks! This was the time of maximum panic. I estimate that the S&P had in fact fallen to 190 or so amidst this chaos, although the low for the day officially recorded in market statistics was 216. (The S&P futures traded as low as 181 on the 20th.) But then, as if out of nowhere, buyers appeared and a furious rally started. During the subsequent week the S&P fluctuated wildly in the 216 to 258 range. Bid-ask spreads for stocks and futures were enormous, reflecting the widespread shock and fear the crash had generated.

The bearish information cascade that developed in response to the crash was certainly visible a week afterward on October 26. The S&P closed that day at 227, more than 24 percent below its 200-day moving average. By all rights this was the definitive indication for the aggressive contrarian trader to increase his stock market exposure to above-normal levels.

Did I do so? No! I was as sh.e.l.l-shocked as everyone else at the time. I knew that at the October 19-20 low points the averages had fallen more than 30 percent from their high points. I knew that this was a typical bear market drop a.s.sociated with the unraveling of a bullish stock market crowd. But the time element just didn't seem to fit. It usually takes many months for a bullish crowd such as the one evident during the summer of 1987 to unravel, but only two months had pa.s.sed since the August 25 top. So I chose then to sit on my hands, do nothing, and await events.

I waited until May 1988, about nine months from the date of the August 1987 top. I estimated that this was the minimum duration of a bear market a.s.sociated with the disintegration of a bullish stock market crowd. But in May the S&P dropped only as low as 248, a level well above its low of the previous October. It was then that I decided that the October low probably ended the bear market. If this was true, I had to increase my stock market allocation to above-normal levels. This I did. Since the hypothesis I adopted in May 1988 was that a bull market was under way, I wanted to follow the special rule appropriate for the first leg up in a bull market. One should wait for an advance of at least 25 percent from the low close, which takes at least six months. Then start watching the 50-day moving average. Cut stock market exposure back to normal levels when this 50-day moving average drops 0.5 percent from a high point.

A 25 percent advance on the bear market low close of 224 on December 4, 1987, would carry the S&P up to 280. This level was first reached on October 20, 1988, 10 months later. From the latter date the 50-day moving average continued to advance. Its first half percent drop became visible on November 6, 1989, when the S&P closed at 332. This was the point at which the aggressive contrarian trader would cut his above-normal allocation to the stock market back to normal levels.

THE 1990 LOW.

Earlier in this chapter I explained how a bearish information cascade developed during the last quarter of 1990 in response to the S&L crisis and the threat of war in the Gulf. On August 21, 1990, the S&P 500 closed at 322, more than 5 percent below its 200-day moving average. At that juncture the aggressive contrarian trader would have moved to a below-normal stock market allocation.

A bearish information cascade would have been very evident by mid-October, which was also a time when the S&P spent several days more than 10 percent below its 200-day moving average. It would have been easy for the aggressive contrarian trader to move to an above-normal stock market allocation at a time when the S&P was trading below the 305 level.

The 1990 bear market was brief, carried the S&P down by 20 percent, and ended at the 295 level on October 11. At the time I was very bullish and believed that a new bull market had started. I reiterated this in several TV appearances on CNBC that fall. During the first leg of a bull market the aggressive contrarian wants to maintain an above-average stock market allocation for at least six months, awaiting an advance from the bear market low point of at least 25 percent. Six months after the October 1990 low the S&P closed at 378, more than 27 percent above that low point. At this juncture the aggressive contrarian trader would start watching for the first drop of 0.5 percent in the S&P's 50-day moving average, the signal to reduce his stock market allocation to normal levels. This happened on July 5, 1991, with the S&P at 374.

LONG TERM CAPITAL MANAGEMENT GOES BUST.

We next fast-forward to 1998. It was a dramatic year in the world's financial markets. On August 17 the Russian government defaulted on its foreign debts. The ruble fell dramatically against other currencies. The global bond market was thrown into turmoil by the Russian financial crisis, and this caused enormous losses for a very big hedge fund, Long Term Capital Management. The fund's losses were so big that they threatened the solvency of several Wall Street banks. Because of this so-called systemic risk, the Federal Reserve orchestrated a buyout of the fund's portfolio by a consortium of these same banks. Not only that, the Fed cut rates substantially and added a great deal of liquidity to the money markets to prevent the panic from spreading.

The first sign of a bearish information cascade was the New York Times New York Times headline on the August 28, 1998, which read: "Markets Jolted, Dow Off 4.1% as the Russian Economic Slide Adds to Pressures on Yeltsin." On September 1, my local paper, the headline on the August 28, 1998, which read: "Markets Jolted, Dow Off 4.1% as the Russian Economic Slide Adds to Pressures on Yeltsin." On September 1, my local paper, the Morristown Daily Record Morristown Daily Record, headlined: "Dow Wipeout-Gains for year lost in 512-point plunge."

The bearish information cascade was also prominent in weekly newsmagazines. On the cover of its August 8 issue the Economist Economist showed a cartoon of a bear wearing sungla.s.ses in which was reflected a chart of falling stock prices. The caption read: "Grin and Bear It." A month later, in its September 14 issue, showed a cartoon of a bear wearing sungla.s.ses in which was reflected a chart of falling stock prices. The caption read: "Grin and Bear It." A month later, in its September 14 issue, Time Time magazine's cover asked: "Is the Boom Over?" and showed a graph of falling stock prices down which tumbled investors. On the cover of its October 12 issue magazine's cover asked: "Is the Boom Over?" and showed a graph of falling stock prices down which tumbled investors. On the cover of its October 12 issue Newsweek Newsweek asked: "The Crash of '99?-It doesn't have to happen but here's why it might." asked: "The Crash of '99?-It doesn't have to happen but here's why it might."

Prior to the Russian crisis, the S&P had reached its high close at 1,187 on July 17, 1998. It would fall to a low close of 957 on August 31 and an intraday low of 923 on October 8. This was a drop of nearly 20 percent on a closing basis, more on an intraday basis. Events moved so swiftly that the aggressive contrarian trader would not have been able to sidestep any of this decline. In fact, the first day on which the S&P closed at least 5 percent below its 200-day moving average was also the day of the low close, 957 on August 31. That was the first opportunity the aggressive contrarian could have taken to reduce his stock market exposure to below-normal levels.

The S&P first closed at least 10 percent below its 200-day moving average on the day of its intraday low, October 8. A bearish information cascade was clearly under way by then. The aggressive contrarian would have increased his stock market allocation to above-normal levels at the 959 level in the S&P.

At this juncture I was willing to bet that a new bull market was beginning. This was a gamble because it had been evident since 1996 that a substantial bull market crowd had developed. Since the S&P had dropped only 20 percent from its highs, there was every reason to think based on historical precedent that a bigger price decline would develop and carry the average down 30 percent or more.

Remember that the first leg of a new bull market generally sees the biggest percentage gains of the entire advance. I didn't want to take the chance of missing it. The aggressive contrarian, having guessed that a new bull market was under way, would want to wait for six months to pa.s.s after the bear market low and for the S&P to rise at least 25 percent from that low. Once these two criteria were met, he would watch for a half percent drop in the 50-day moving average to signal a reduction in stock market exposure.

I decided to adopt a compromise policy that would protect me if a bigger decline was at hand. I would stick with my above-normal stock market allocation until the 50-day moving average turned downward by 0.5 percent. If this happened, I would move back to a below-normal allocation even if six months had not pa.s.sed and the market had not risen 25 percent.

In the event, it took only a little more than two months for the S&P to move above its July 17 high and at no time did the 50-day moving average drop 0.5 percent from a high during that rally. Once new highs were attained, I adopted the six-month, 25 percent rule appropriate for the first leg of a bull market. A move back down to a normal stock market allocation was triggered by a half percent drop in the 50-day moving average on September 20, 1999, with the S&P closing at 1,336. The bull market that started from the 1998 low would not end until the following March at a high close of 1,527 in the S&P.

CHAPTER 13.

Collapse of the Bubble: The 2000-2002 Bear Market End of the bubble bull market * * the conservative contrarian stays until the lights go out the conservative contrarian stays until the lights go out * * bear market signal in January 2001 bear market signal in January 2001 * * how far down? how far down? * * bearish information cascade after the 9/11 terrorist attack bearish information cascade after the 9/11 terrorist attack * * a long wait for a signal a long wait for a signal * * the bears party in July 2002 the bears party in July 2002 * * an amateur contrarian fades the crowd an amateur contrarian fades the crowd * * the conservative contrarian waits until June 2003 the conservative contrarian waits until June 2003 * * the aggressive contrarian trades the bear market the aggressive contrarian trades the bear market * * Wall Street wreck Wall Street wreck * * Newsweek predicts a bear market Newsweek predicts a bear market * * my thinking during the summer rally after the top my thinking during the summer rally after the top * * October 11 bear market signal October 11 bear market signal * * a chance to buy in March 2001 a chance to buy in March 2001 * * out again in April out again in April * * trading after 9/11 trading after 9/11 * * buying near the bear market low buying near the bear market low * * the first leg up in a new bull market the first leg up in a new bull market END OF THE GREAT BULL MARKET.

The greatest bull market in the history of the United States began from the lows established in the Dow Jones Industrial Average and the S&P 500 index in August 1982. On August 12 the Dow closed at 776.92 and the S&P at 102.42. An astounding 18-year advance culminated on January 14, 2000, in the Dow when it closed at 11,722.98. The S&P reached its bull market peak on March 24, 2000, at 1,527.46. The home of the bubble stocks, the NASDAQ Composite index, moved up from 159 in August 1982 to a high close of 5,048 on March 10, 2000.

How would the contrarian trader have been positioned as these averages were ending this record-breaking bull market in early 2000? Keep in mind that the biggest mistake any contrarian trader can make is to be underinvested for any substantial period of time in an extended bull market. Beating the market means outperforming the buy-and-hold strategy, and it is during long bull markets that this strategy s.h.i.+nes. So even after the contrarian trader had identified the bubble crowd in late 1996 he would only have maintained his stock market exposure at normal levels. A move to below-normal exposure for the conservative contrarian following the Contrarian Rebalancing strategy would await a turndown in the 200-day moving average of the S&P 500 by 1 percent from its bull market high. The aggressive contrarian would wait to see a drop in the S&P 500 of 5 percent below its 200-day moving average. These tactics would help both types of contrarian trader remain invested in the bubble bull market as long as was prudent.

CONTRARIAN REBALANCING DURING THE 2000-2002 BEAR MARKET.

The 200-day moving average of the S&P 500 reached a peak of 1,447.54 on October 5, 2000, and had fallen 1 percent from that level by January 2, 2001. On January 2 the S&P closed at 1,283. At this juncture the conservative contrarian trader would have had ample reason to reduce the allocation to the stock market in his portfolio to below-normal levels. In our running example where normal is a 60 percent allocation, a below-normal allocation would perhaps be 30 percent or even less.

I want to emphasize here a very important point: The contrarian trader is emphatically not not in the business of picking tops and bottoms in the stock market averages. Instead he is in the business of outperforming the buy-and-hold investment policy. Doing this does not require getting out of stocks close to the tops of bull markets and getting back in near the lows of bear markets. Rather it requires the contrarian trader to in the business of picking tops and bottoms in the stock market averages. Instead he is in the business of outperforming the buy-and-hold investment policy. Doing this does not require getting out of stocks close to the tops of bull markets and getting back in near the lows of bear markets. Rather it requires the contrarian trader to lean against the crowd lean against the crowd, to invest opposite the preferences of well-established market crowds by identifying the point where these crowds are liable to begin disintegrating. It is very hard to identify the top of a bull market, but much easier to see when a bullish crowd is about to disintegrate after such a top has probably developed.

THE LONG WAY DOWN AGAIN.

The most important feature of the 2000-2002 bear market from the contrarian trader's standpoint was that it developed from the collapse of a stock market bubble. The bubble had developed during the last years of the 1990s. The information cascade in the media that built the bubble's stock market crowd was easy to identify. By any historical standard the stock market was grotesquely overvalued at its high point in the year 2000.

Stock market bubbles do not develop very often, but when they do the ensuing bear market is likely to be long and severe. This bear market was no exception. By the time it ended in October 2002, the Dow had dropped 39 percent, the S&P 500 had dropped 50 percent, and the NASDAQ Composite nearly 80 percent from their high points in early 2000. Depending on which average is used as a measuring stick, the bear market lasted between 31 and 33 months. Historically, the last comparable drop in extent and duration was the Great Crash during 1929-1932, which ushered in the Great Depression of the 1930s.

The contrarian trader knows that the postbubble bear market is likely to be long and severe. For the conservative contrarian who is employing the Contrarian Rebalancing strategy, this has important implications. First, he knows that a severe bear market will probably last anywhere from 18 months to three years. He expects the market to drop at least 30 percent and probably closer to 50 percent during this time. He wants to take advantage of these historical tabulations and the information in his media diary to a.s.sume an above-normal stock market allocation as soon as is prudent-that is, as soon as he sees evidence that the bear market has ended.

Let's see how these goals could have been achieved during the 2000-2002 bear market.

CONTRARIAN REBALANCING DURING THE CRASH.

In Chapter 11 I explained that a conservative contrarian trader should increase his stock market allocation to above-normal levels once he has evidence that a bear market is complete. This requires three conditions to be met. First, he must detect a bearish information cascade in his media diary, a cascade intense enough to build a substantial bearish stock market crowd. Second, the S&P 500 should have dropped as much as is typical for the type of bear market that is under way. So if it is a bear market attending the collapse of a bullish stock market crowd (a.s.sociated with some sort of bubble), then he would expect a drop in the S&P of 30 percent or more. Otherwise, a normal bear market would drop the index only 20 to 30 percent. Finally, the 200-day moving average of the S&P 500 must turn upward by 1 percent from whatever low it made when the first two conditions were satisfied. Once this third condition is met, the conservative contrarian increases his stock market allocation to above-normal levels.

Since the biggest stock market bubble in U.S. history was a.s.sociated with the 2000 high point in the market averages, the conservative contrarian trader would expect the subsequent bear market to drop the S&P at least 30 percent. Once this happens, he determines whether there is evidence of a bearish stock market crowd in his media diary. The high close in the S&P was 1,527 on March 24, 2000. A 30 percent drop from 1,527 would bring the average down to 1,069. On September 17, 2001, the S&P closed at 1,038, its first close below the 30 percent mark. Was there a bearish information cascade under way at the time? Was there a bearish stock market crowd visible?

My answer to both these questions is yes, but for reasons that are a bit unusual. The World Trade Center in New York City was attacked by terrorists on September 11, 2001. The stock market was closed for a week afterward and reopened on September 17. The S&P had been dropping steadily for almost four months from a short-term high point it made on May 21, 2001, at the 1,313 level. The impact of the terrorist blow on the financial markets was enormous, but it was not recorded on newspaper front pages or on magazine covers for obvious reasons. Instead it was political and military news that dominated the media. Even so, page 1 of the New York Times New York Times business section on September 12, 2001, was headlined: "The Financial World Is Left Reeling by Attack." The September 21 edition of the business section on September 12, 2001, was headlined: "The Financial World Is Left Reeling by Attack." The September 21 edition of the Chicago Tribune Chicago Tribune had a page 1 stock market story, complete with charts showing drops in all the averages during the preceding week. It was headlined: "America's Psyche Takes Another Blow, Old a.s.sumptions No Longer Apply; 'There Is Fear in the Marketplace.'" The previous day the S&P had closed at 984. So I think it is fair to say that the conservative contrarian trader would have been justified in concluding that a bearish information cascade was under way. He would then await a move upward of 1 percent in the 200-day moving average of the S&P 500. had a page 1 stock market story, complete with charts showing drops in all the averages during the preceding week. It was headlined: "America's Psyche Takes Another Blow, Old a.s.sumptions No Longer Apply; 'There Is Fear in the Marketplace.'" The previous day the S&P had closed at 984. So I think it is fair to say that the conservative contrarian trader would have been justified in concluding that a bearish information cascade was under way. He would then await a move upward of 1 percent in the 200-day moving average of the S&P 500.

This would have been a long and trying wait, for the desired 1 percent upturn in the 200-day moving average did not develop until June 13, 2003, when the S&P itself closed at 988. There were fireworks in the marketplace in the meantime. The S&P moved as high as 1,178 in January 2002 and as low as 768 later in October that same year. These fluctuations occurred against the backdrop of a second bearish information cascade, which developed during the summer of 2002.

The first solid evidence for this second bearish information cascade appeared in the July 13, 2002, edition of the New York Times New York Times. This was a page 1 stock market story, although it was not the day's headline story. The story appeared above the fold and was accompanied by bearish charts of the S&P 500, the federal budget deficit, and plunging consumer confidence levels. The story's headline read: "Bears on Prowl As Market Ends a Dreary Week." The following day saw another above-the-fold, page 1 stock market story, again not the day's headline. The story was headed: "Stocks' Slide Is Playing Havoc with Older Americans' Dreams." Finally, on July 17 the stock market made it into the Times Times's headlines: "Fed Chief Blames Corporate Greed; House Revises Bill-Greenspan Cites Cause for Investor Woes-Dow Drops Again." More evidence came from the Times Times's July 20 page 1 headline: "Market Continues Four-Month Rout; Dow Plunges 390." That same day the Chicago Tribune Chicago Tribune chimed in with this headline: "Dow Dives to Four-Year Low." And on July 23 the chimed in with this headline: "Dow Dives to Four-Year Low." And on July 23 the Tribune Tribune headlined: "Dow Slides below 8,000 to '98 Level." headlined: "Dow Slides below 8,000 to '98 Level."

My wife, an amateur contrarian trader, increased her stock market allocation on July 22, 2002, the first market day after the two July 20 headline stories. The S&P closed on July 22 at the 820 level, her trade price since she was investing in S&P 500 index funds. My wife acted as an aggressive contrarian would, but when would a conservative contrarian a.s.sume an above-normal stock market allocation? Certainly the market had fallen far enough, almost 50 percent as measured by the S&P, to deflate the preceding bubble. There was a prolonged bearish information cascade, which had built a powerful bear market crowd. All that was necessary to trigger an allocation increase would be a turn upward by 1 percent in the 200-day moving average of the S&P 500. This happened on June 13, 2003, when the S&P 500 closed at 989. On that day the 200-day moving average of the S&P reached 887.96, a 1 percent move up from its bear market low point of 879.03 reached on May 1, 2003.

So we see that the conservative contrarian trader would have reduced his stock market allocation to below normal on January 2, 2001, with the S&P at 1,283. He then would have moved his allocation to above normal at S&P 988 on June 13, 2003. Notice two important things: He did not go to a below-normal allocation until the S&P had already dropped a substantial amount from its high close at 1,527. And he did not restore his allocation to normal and then to above-normal levels anywhere near the low bear market close of 777. This ill.u.s.trates a very important point: It is not necessary to sell near the top or to buy near the bottom to improve one's investment performance relative to the benchmark buy-and-hold strategy. All that is needed is to buy at levels that are on average significantly lower than the levels at which you sell.

THE AGGRESSIVE CONTRARIAN DURING THE 2000-2002 BEAR MARKET.

The 2000-2002 bear market years were punctuated by three very substantial rallies that carried the S&P up at least 20 percent. There were many wonderful opportunities for the aggressive contrarian trader to buy into these three big rallies and to sell or even sell short in antic.i.p.ation of the subsequent declines. However, in this chapter I will pa.s.s over the short selling opportunities open to the aggressive contrarian trader during this postbubble bull market. Why?

I think that trading on the short side of the stock market, even via inverse exchange-traded funds (ETFs), is a game that should be played only by experts. It requires great flexibility of mind and a completely unbiased view of market opportunities. These characteristics are not well developed in a novice contrarian trader. Experts don't need my help, but I want to urge beginners not to get too far out over their skis. The stock market is a treacherous realm for any investor, and beginners are well advised to focus on the one activity that is favored by a secular uptrend in the U.S. stock market: buying and selling long positions. So in the rest of this chapter I point out some of the opportunities that were open to an aggressive contrarian trader who was content to manage only long positions during the 2000-2002 bear market.

A WALL STREET WRECK.

The S&P 500 established its closing high for the bubble bull market on March 24, 2000, at the 1,527 level. Naturally no contrarian trader would have known then that 1,527 was destined to be the bull market's high close. But every contrarian trader would have seen plenty of evidence of extreme overvaluation in the stock market. And every contrarian trader's media diary would have contained plenty of evidence of the bullish information cascade that had created the bullish bubble crowd in the stock market. So, at the very least, every contrarian trader would have adopted a wary view of the market and would have been alert for signs that a bear market had begun.

In March 2000 I believed that despite these warning signs the bull market had further to run. My reasoning was based on my historical market tabulations. I thought that a mini-bear market had ended in October 1998 at the intraday 923 low in the S&P 500. From there I thought that a normal bull market would evolve, one that according to my tabulations would last about two years and carry the market up about 65 percent or perhaps a little more. A 65 percent advance from the 923 level was achieved on March 23, 2000, when the S&P closed at 1,527. But the two-year guideline would not be achieved until October 2000. So I expected the ultimate market top to occur sometime during the September-October 2000 time frame.

During bull markets the aggressive contrarian trader should always reduce his stock market allocation to normal levels once the S&P has rallied at least 15 percent from some short-term low and has made a new bull market high. In March 2000 the aggressive contrarian trader might have gotten lucky and reduced his stock market exposure to normal levels very near what proved to be the ultimate top. Why? There had been a short-term low on February 25, 2000, with the S&P closing at 1,333, about 2 percent below its 200-day moving average. That short-term low had been accompanied by a brief bearish information cascade, which was highlighted by a page 1 story in the February 26 edition of the New York Times New York Times. The story was headed: "Stocks in Turmoil as Worries Grow on Higher Rates-Dow Closes below 10,000." If an aggressive contrarian had taken an above-normal stock market allocation near the February 25 low close, he would have returned to a normal allocation after a 15 percent advance in the S&P (the 1,533 level, which was reached intraday on March 24, but never reached on a closing basis).

As mentioned, there was no way to know at the time that the March 24 close at 1,527 would be the bull market top. It is for this reason that I don't recommend going to below-normal stock market allocations during a bull market, even if you are an aggressive contrarian. Instead, the right policy for an aggressive contrarian trader in an ongoing bull market is to await an opportunity to increase stock market exposure to above-normal levels. As was ill.u.s.trated in the case of the February 25 low at 1,333, this would require a drop in the S&P 500 to or slightly below its rising 200-day moving average at a time when a short-run bearish information cascade was under way. At that point the aggressive contrarian can a.s.sume an above-normal stock market allocation even though even though he knows full well that a bear market might begin at any time. The reason for this is that it is impossible to guess just how far a stock market bubble might inflate, and it is usually best for even the aggressive contrarian trader not to implement a bear market strategy until he sees the S&P drop 5 percent below its 200-day moving average, an event that did not occur until October of that year. he knows full well that a bear market might begin at any time. The reason for this is that it is impossible to guess just how far a stock market bubble might inflate, and it is usually best for even the aggressive contrarian trader not to implement a bear market strategy until he sees the S&P drop 5 percent below its 200-day moving average, an event that did not occur until October of that year.

A short-run bearish information cascade developed quickly after the March top, in April 2000. The market averages, especially the NASDAQ Composite of bubble stocks, dropped sharply from their March high points. On April 5, the New York Times New York Times headlined on page 1: "Nasdaq Recovers after a Free Fall in a Wary Market." This headline story was accompanied by a color photo of a floor trader looking distressed as background to a graph showing the NASDAQ Composite's gyrations the previous day. At the close on April 4 the S&P stood at 1,494, a full 8 percent above its 200-day moving average. Moreover, it had dropped for less than two weeks from its March top and the drop had carried it down only about 2 percent on a closing basis. So while it appeared that a bearish information cascade may have begun on April 5, the market had not dropped near its 200-day moving average, nor had it dropped 5 to 10 percent for about one to three months from its high, these being the parameters for normal bull market reactions. So an aggressive contrarian trader would still be waiting for a better opportunity before increasing his long-side exposure to the stock market. headlined on page 1: "Nasdaq Recovers after a Free Fall in a Wary Market." This headline story was accompanied by a color photo of a floor trader looking distressed as background to a graph showing the NASDAQ Composite's gyrations the previous day. At the close on April 4 the S&P stood at 1,494, a full 8 percent above its 200-day moving average. Moreover, it had dropped for less than two weeks from its March top and the drop had carried it down only about 2 percent on a closing basis. So while it appeared that a bearish information cascade may have begun on April 5, the market had not dropped near its 200-day moving average, nor had it dropped 5 to 10 percent for about one to three months from its high, these being the parameters for normal bull market reactions. So an aggressive contrarian trader would still be waiting for a better opportunity before increasing his long-side exposure to the stock market.

Things started to fall into place on April 13. The New York Times New York Times printed a page 1 stock market story, not the headline but appearing above the fold. The story's headline read: "In Only a Few Weeks, Nasdaq Falls 25.3% from Its Pinnacle-Steep Drop Suggests a Technology Bear Market." Then, on Sat.u.r.day, April 15, the printed a page 1 stock market story, not the headline but appearing above the fold. The story's headline read: "In Only a Few Weeks, Nasdaq Falls 25.3% from Its Pinnacle-Steep Drop Suggests a Technology Bear Market." Then, on Sat.u.r.day, April 15, the Times Times printed a multicolumn, bold print, page 1 headline: "Stock Market in Steep Drop As Worried Investors Flee; Nasdaq Has Its Worst Week." The local printed a multicolumn, bold print, page 1 headline: "Stock Market in Steep Drop As Worried Investors Flee; Nasdaq Has Its Worst Week." The local Morristown Daily Record Morristown Daily Record had as its headline that day: "Wall Street Wreck." had as its headline that day: "Wall Street Wreck."

Clearly a short-run bearish information cascade had taken hold and built up a short-lived bearish crowd, one typical of short-term low points in a bull market. Moreover, on April 14 the S&P 500 had closed at 1,357, 2 percent below its rising 200-day moving average, below its 50-day moving average, and nearly 12 percent below its March top at 1,527. This combination of circ.u.mstances made this an ideal buy spot for an aggressive contrarian trader, a place where it made sense to restore his stock market allocation to normal or even to above-normal levels. As far as anyone could tell, the bull market was still alive and well.

There is a magazine cover that appeared in April 2000 that merits the attention of an aspiring contrarian trader. On the cover of its April 24, 2000, issue, Newsweek Newsweek magazine showed a photograph of a gla.s.s of water in which two antacid tablets were dissolving. The cover caption read: "Is the Bull Market Really Over?" This is an example of an eerily prescient magazine cover. Such covers are very unusual but do appear sometimes, and it is important for the contrarian trader not to be misled by them. A naive contrarian would be tempted to respond to the cover's question by guessing that the bull market was magazine showed a photograph of a gla.s.s of water in which two antacid tablets were dissolving. The cover caption read: "Is the Bull Market Really Over?" This is an example of an eerily prescient magazine cover. Such covers are very unusual but do appear sometimes, and it is important for the contrarian trader not to be misled by them. A naive contrarian would be tempted to respond to the cover's question by guessing that the bull market was not not over. And he would have been wrong! The point here is that the cover was trumped by the clear and overwhelming evidence that a stock market bubble had already formed. And historical experience suggested that it would take months and probably years to deflate. over. And he would have been wrong! The point here is that the cover was trumped by the clear and overwhelming evidence that a stock market bubble had already formed. And historical experience suggested that it would take months and probably years to deflate.

THE SUMMER RALLY.

The low close for the S&P 500 in April 2000 occurred on April 14 at 1,356. As I have pointed out, there was ample reason for the aggressive contrarian trader to move to an above-normal stock market allocation during the short-run bearish information cascade that developed that month. But there was no reason for him to believe that the bear market a.s.sociated with the disintegration of the bullish bubble crowd had yet begun. The bull market that started from the October 1998 low had run only 17 months, well short of the average of 20 to 24 months. True, it had carried the S&P up 65 percent at the March 2000 top. But the contrarian is always acutely aware that stock market bubbles can inflate far beyond what is suggested by any historically based statistical projection. So at the very least the aggressive contrarian trader would await a drop of 5 percent in the S&P below its 200-day moving average before switching over to a bear market trading strategy. In the meantime his problem was to decide when to reduce his above-normal allocation to normal levels.

Here is how I handled this problem at the time. As I pointed out earlier in this chapter, I thought the bull market that started from the October 1998 low would continue into the September-October 2000 time frame. At that point I expected that the bubble crowd would begin to disintegrate and a bear market would take hold. I also knew the following important characteristic of the 1998-2000 bull market. There had been two short-term reactions prior to the one that developed during March-April 2000. After each of these two reactions had ended, the S&P 500 worked its way to a new high bull market close within six weeks. Thus I decided to use this six-week time interval as a measuring stick to gauge the strength of the rally from the April lows.

On June 19 the S&P reached a new closing high of 1,486 for the rally from the April low. Eight weeks had pa.s.sed, but the average still had not managed to move above its 1,527 high close of March 24, 2000. This I took as a warning sign that the bull market top may already have been seen. But it was only a warning. I resolved to move into bear market mode if I saw a daily close in the S&P that was more than 1 percent below its 200-day moving average. Such a close would occur while the 200-day moving average was still rising rising, but I believed that an aggressively bearish stance would be warranted since it was clear that an enormous bullish crowd had formed and that the ideal time frame for a top, September-October 2000, was rapidly approaching.

On September 1, 2000, the S&P 500 reached a rally high of 1,521, close to but still below its bull market high close of 1,527. On September 26 the S&P closed at 1,427, more than 1 percent below its 200-day moving average, which then stood at 1,447 and was still rising. At that juncture I a.s.sumed a bear market posture for my contrarian trading. As a matter of fact, I had already reduced my above-normal stock market exposure to normal levels in July as the market rallied, this because more than six weeks had pa.s.sed since the April low without a new bull market high. In late September I reduced my stock market exposure still further, to substantially below-normal levels. This was a more aggressive approach than I recommended in Chapter 11, but then I have a lot more experience than a typical contrarian.

What would a typical aggressive contrarian have done had he reduced his allocation to normal levels by using the same tactic employed earlier that year on the rally from the February 25 low? The bull market top was already in place, and the S&P never rallied as much as 15 percent from its April 14 low. As was discussed in Chapter 11, one way for an aggressive contrarian to identify a new bear market is to watch for a move in the S&P that carries it 5 percent below its 200-day moving average after a normal bear market. On October 11, 2000, the S&P first dropped 5 percent below its 200-day moving average, closing at 1,365. At his juncture the aggressive contrarian trader would a.s.sume a below-normal stock market allocation. In particular he would sell whatever he had bought previously near the April 2000 low point, probably at a small loss.

THE MARCH 2001 PLUNGE.

Beginning on October 11, 2000, with the S&P at 1,365, the aggressive contrarian would have had ample reason to think a bear market was under way. Since there was plenty of evidence that a stock market bubble had formed during the 1994-2000 stock market advance, the reasonable expectation was that this bear market would drop the averages at least 30 percent from their March high points.

On March 12, 2001, the S&P 500 dropped below the 1,200 level to close at 1,180, its lowest level in more than two years. The NASDAQ Composite average dropped 6 percent that day, bringing its total decline from its March 2000 top at 5,048 to 61 percent. Clearly the bubble had popped. The March 13 edition of the New York Times New York Times headlined: "Markets Plunge in Wide Sell-Off; Nasdaq Falls 6%." A bearish information cascade had begun, and the aggressive contrarian trader would immediately check the position of the S&P relative to its 200-day moving average. At its close on March 12 the S&P stood almost 16 percent below that moving average and thus justified increasing stock market exposure, provided that there was a well-developed bearish information cascade in progress and that the market had been falling for two months or more since its last short-term top (which in this case had occurred in late January). Had the cascade then gone far enough to indicate the presence of at least a short-term bearish crowd? My own answer to that question was that it had not. This was only the very first headline of a developing cascade. Moreover, the market had been dropping for less than two months after its top in late January. A substantial bear market appeared to be under way, especially in the NASDAQ Composite index. So I wanted to see more evidence than just a single headline in my media diary before concluding there was a bearish crowd big enough to justify increasing my stock market allocation. headlined: "Markets Plunge in Wide Sell-Off; Nasdaq Falls 6%." A bearish information cascade had begun, and the aggressive contrarian trader would immediately check the position of the S&P relative to its 200-day moving average. At its close on March 12 the S&P stood almost 16 percent below that moving average and thus justified increasing stock market exposure, provided that there was a well-developed bearish information cascade in progress and that the market had been falling for two months or more since its last short-term top (which in this case had occurred in late January). Had the cascade then gone far enough to indicate the presence of at least a short-term bearish crowd? My own answer to that question was that it had not. This was only the very first headline of a developing cascade. Moreover, the market had been dropping for less than two months after its top in late January. A substantial bear market appeared to be under way, especially in the NASDAQ Composite index. So I wanted to see more evidence than just a single headline in my media diary before concluding there was a bearish crowd big enough to justify increasing my stock market allocation.

Such evidence was not long in coming. The March 26 issues of Time Time magazine, magazine, Newsweek Newsweek, and U.S. News & Word Report U.S. News & Word Report all had bearish stock market covers. These issues were on the newsstand about a week earlier than their publication dates. Both all had bearish stock market covers. These issues were on the newsstand about a week earlier than their publication dates. Both Time Time and and U.S. News U.S. News had photographs of growling bears on the cover. The had photographs of growling bears on the cover. The Newsweek Newsweek cover asked: "How Scared Should You Be?" It is very unusual, even in a bear market, to see three such magazine covers in the same week. I took this as solid evidence that a good-sized bearish crowd had developed and that a short-term stock market low was at hand. The average price of the S&P 500 during the 10 trading days ending March 26 was 1,153 and represents a fair estimate of the price at which an aggressive contrarian could easily have increased his stock market exposure. The actual short-term closing low for the S&P occurred on April 4 at 1,103. The intraday low occurred on March 22 at the 1,081 level. cover asked: "How Scared Should You Be?" It is very unusual, even in a bear market, to see three such magazine covers in the same week. I took this as solid evidence that a good-sized bearish crowd had developed and that a short-term stock market low was at hand. The average price of the S&P 500 during the 10 trading days ending March 26 was 1,153 and represents a fair estimate of the price at which an aggressive contrarian could easily have increased his stock market exposure. The actual short-term closing low for the S&P occurred on April 4 at 1,103. The intraday low occurred on March 22 at the 1,081 level.

Notice that the low close of 1,103 was not not 30 percent below the March 2000 high close of 1,527. The drop in the S&P was not yet typical of a bear market accompanying the disintegration of a bubble crowd. Such bear markets typically drop the S&P at least 30 percent and often more. For this reason the aggressive contrarian would 30 percent below the March 2000 high close of 1,527. The drop in the S&P was not yet typical of a bear market accompanying the disintegration of a bubble crowd. Such bear markets typically drop the S&P at least 30 percent and often more. For this reason the aggressive contrarian would not not interpret any subsequent move in the S&P to a point 5 percent above its 200-day moving average as a sign that a new bull market was under way. In this particular case this cautionary observation proved to be moot. In the event, the S&P never moved above its 200-day moving average until after it had fallen more than 30 percent from its bubble high point at 1,527. interpret any subsequent move in the S&P to a point 5 percent above its 200-day moving average as a sign that a new bull market was under way. In this particular case this cautionary observation proved to be moot. In the event, the S&P never moved above its 200-day moving average until after it had fallen more than 30 percent from its bubble high point at 1,527.

Having increased his stock market exposure to above-normal levels in March, the aggressive contrarian trader would next be looking for an opportunity to sell his newly acquired long position and move back down to below-normal exposure. After all, as far as he could tell the bear market was still in progress because the S&P had not dropped at least 30 percent from its bull market top. The bear market trading strategy described in Chapter 11 for the aggressive contrarian dictates that he wait for the average to move 1 percent above its 50-day moving average. This happened on April 18 when the S&P closed at 1,238.

The interesting thing about April 18 was that it was the day of a surprise rate cut by the Federal Reserve. Since I watch the markets during the day, I was able to reduce my stock market exposure about an hour after the Fed made its announcement. This was an example of fading bullish news in a bear market if it generates a big rally. It made good sense at the time because the news itself sent the S&P 500 up almost 5 percent within about 30 minutes after the announcement. I knew that the market would be pus.h.i.+ng above its 50-day moving average.

TERRORISTS ATTACK ON 9/11.

With a below-average stock market allocation in place by the close on April 18, the aggressive contrarian trader would again be looking for another bearish information cascade to develop when the S&P was trading at least 10 percent below its 200-day moving average after a drop lasting at least two months from its last short-term high point. The price and time parameters were met on September 6, 2001, with the S&P closing at 1,106. But the average had not yet dropped back below its March 2001 low point, so it is not surprising that no bearish information cascade was then evident.

The terrorist attack on New York City's World Trade Center on September 11 changed the situation dramatically, as I described earlier in this chapter. Bearish sentiment became widespread. The aggressive contrarian trader would have easily been able to increase his stock market allocation while the S&P was trading below 1,000. The average reached its closing low at 966 on September 21 and its intraday low of 945 that same day.

Every trade requires a buy and a sell to be complete. The aggressive contrarian trader who bought below the 1,000 level would be looking for the S&P to move 1 percent above its 50-day moving average before again reducing his stock market allocation. This happened on November 5, 2001, when the S&P closed at 1,102. The rally from the September lows eventually carried the S&P 500 to a high close of 1,173 on January 4, 2002.

END OF A BEAR MARKET.

During all of 2001 and 2002 the S&P 500 never closed as much as 5 percent above its 200-day moving average. Indeed, for most of this time it stayed below its moving average. The aggressive contrarian trader never had reason to doubt that a bear market was in progress. During this time his typical stock market allocation was at below-normal levels, but he took advantage of bearish information cascades to temporarily increase stock market exposure. He last did this in September 2001, but returned to a below-normal allocation in early November.

By June 21, 2002, the S&P had again dropped 10 percent below its 200-day moving average. However, the S&P still had not dropped below its September 21, 2001, low, so it was not surprising that no bearish information cascade was evident in my media diary at that date. By mid-July, however, that low had been broken and a bearish cascade was well under way. I explained the details earlier in this chapter. The closing low for the S&P was 798 on July 23. I think the aggressive contrarian trader had plenty of opportunity to increase his stock market exposure below the 900 level that July. For the sake of discussion, let's suppose he did so at an average price of 860.

This move to an above-normal allocation did not last long. The aggressive contrarian trader would have observed the S&P close at 951 on August 19, more than 1 percent above its 50-day moving average. Since the S&P was still below its 200-day moving average, he would then have reduced his stock market exposure to below-normal levels at that time.

During the entire July-October 2002 time frame the S&P 500 remained at least 10 percent below its 200-day moving average. Thus anytime that the bearish cascade again became visible the aggressive contrarian trader would be justified in once more increasing his stock market exposure after having reduced it on August 19. The only caveat I would add is that he would also want to be sure that the average was within a few percentage points of its July low at the same time.

As it happened, there was not much evidence for a renewed cascade when the S&P established its closing low for the bear market on October 9, 2002, at the 777 level. My media diary is filled with bearish news stories that were prevalent at the time, but there were no headline stories evident. However, there were some page 1 stories. The October 9 edition of the Chicago Tribune Chicago Tribune had a page 1, above-the-fold news a.n.a.lysis headlined: "Risk-p.r.o.ne Economy Limps Along." The a.n.a.lysis was accompanied by graphs showing the downward course of the Dow Jones Industrial Average. The following day the had a page 1, above-the-fold news a.n.a.lysis headlined: "Risk-p.r.o.ne Economy Limps Along." The a.n.a.lysis was accompanied by graphs showing the downward course of the Dow Jones Industrial Average. The following day the Wall Street Journal Wall Street Journal had a significant page 1 story that was not a headline story. It appeared above the fold and was accompanied by charts showing dropping stock market prices. The story w