The case for optimism and pessimism

by JDH on May 29, 2010

Are you an optimist, or a pessimist? Is the glass half full, or half empty? I have long believed that our world view influences our interpretation of daily events. Do you believe in God, or not? If you do, and you hear a story of someone whose sickness was cured, you will assume God was responsible. If you don’t believe, you will assume that the doctors were responsible for the cure. The facts are the same in either case, but our pre-existing views, our a priori belief, influences our interpretation of events.

What do your beliefs tell you about the market? It’s easy for the bull, the optimist, to make the case that all is well with the markets.

This 25 year chart of the Dow shows a long bull market run. The crash of 1987 is a mere blip. Even the crash of 2008 only served to return the Dow back down to it’s long term uptrend line. The recovery in 2009 and 2010 has broken the red down trend line started in 2008, so obviously the correction is over, and all is well. An optimist would assume that the market will continue to recover, and we will see Dow 14,000 sometime later this year, or early in 2011.

The optimist would also point out, as Mr. Dines did in his most recent edition of The Dines Letter, that since March 2009 there have been seven corrections of 4% or more on the Dow, and all of them have resulted in subsequent rises of 7% or more. Whether the May “flash crash” will evolve into another multi-point rally remains to be seen, but the case can easily be made that the trend is up, so jump on board.

Of course the case for pessimism is also easy to make.

First, the market is up huge from it’s lows, and nothing goes up forever, so at some point a serious correction is inevitable.

Second, 70% of the trading sessions in May saw moves of more than 100 points in Dow. There were 16 consecutive sessions with 200 plus point intra-day swings. That’s what you call volatility, and volatility is a characteristic of a bear market, not a bull market.

Third, volume is falling on the markets. Investors appear to lack the a priori belief that this market is going higher.

Finally, it can easily be argued that the market’s gains are due entirely to massive government stimulus. Assuming the government can’t stimulate forever, at some point the buyers leave, and the market drops. Or crashes.

I am of course ignoring all of the other fundamental problems we face, like the oil volcano in the Gulf that will be a problem for many months to come, high unemployment, etc.

I realize the chart looks good, but I’m still a pessimist at this stage. I will continue to look for bargains; my recent purchase of CMK.TO – Cline Mining Corporation has worked out great; new analyst coverage this week helped the stock bounce, so I’m holding. I will probably begin to cover or thin out my gold holdings over the next week, as gold has risen, and the summer months are seasonally weak, so it’s time to raise some cash.

Those are my thoughts. Happy Memorial Day for my American friends. See you next week.

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