Market Psychology Update

I just discovered the MacroStory blog as it was recommended by the M3 Financial Sense blog. I found the psychology section of their market recap of the week to be particularly interesting; and to be exactly what I am thinking about the market at this stage:

Market psychology is key right now. Most traders do not believe in the weak macro data nor the reality that corporate profits are losing steam. For two years most have made money doing nothing. People have bought bad stocks at bad prices, have not used stops, have sat on losses and still been able to profit. Markets don’t work that way in the long term. What we have had is a stealth selloff. The duration of this selloff has been long but the size has been relatively small.

The boiling frog analogy is best to describe this selloff. Very slowly the water temperature is turned up until it is too late for the frog to escape. In this case a majority of market participants who are all in and leveraged (based on record low cash levels and record high margin levels) are in denial. They are waiting for that bounce they have seen for two years.

This intraday volatility is only reinforcing their views that it will in fact bounce to new highs. When reality finally kicks in that this dip should NOT be bought then markets will begin to sell off and then we can talk about a tradable bottom.

Not a single market pundit is worried about the market — oh yes, bullishness has decreased and the P/C ratio is very high — but nobody is recommending to sell, everybody is talking about a healthy correction, the VIX and VXO indices remains extremely low given what is happening in the world and the financial markets. Complacency remains extreme.

Just look at the bounce in extremely speculative shares such as LinkedIn, Pandora, the Russell 2000, Baidu... Junk is over-performing by a very high margin. This cannot be showing any fear or capitulation.