As you can see from the chart above, the S&P 500 has broken the accelerated downtrend it’s been in since September.

Now, it’s true that this chart is only current as of Monday’s close. I’m writing you these words early Tuesday morning before hopping on a plane.

Perhaps while I’m up in the air at 35,000 feet, Treasury Secretary Paulson will say or do something alarmingly idiotic and help stocks return to form.

But if not, just imagine! The very idea that stocks don’t always go down and down… who’d have thunk it?

Whisper it Quietly

Okay, that was a wee bit of sarcasm (in case you hadn’t noticed).

If I felt like really pushing my luck though – being out of pocket for Tuesday’s market action and all – I could point out that the upmove from 750 to just under 910 on the S&P is a greater than 20% advance… and thus technically constitutes a new bull market.

Not that it’s time to go around shouting new bull market! That would be insane, and worse still not very helpful in terms of making money. Plus, with the volatility levels we’ve seen, 20% just doesn’t carry the same heft that it used to.

Wholly artificial and backward-looking labels aside, it’s eye-opening to note the backdrop against which stocks chose to rise these past few days. Just consider what the beleaguered bulls had to deal with:

• We got word of the ugliest jobs report since 1974 – 533,000 jobs lost – with gloomier-than-thou pundits falling all over themselves to point out why the report was actually even worse than it seemed.
• Treasury bond yields effectively hit zero as panicked investors parked their last slugs of cash with Uncle Sam. On Friday the U.S. Treasury three-month T-bill yield fell to 0.01 percent.
• Credit spreads on investment-grade bonds versus treasuries – a measure of what it costs for companies to borrow money – widened to super-panic levels last week, as the below FT chart shows.

In spite of that awful trifecta, stocks managed to put in a rather impressive reversal Friday… then powered higher again on Monday with news of the Obama infrastructure plan.

If Mr. Market has been fighting off a fever, we may have just seen that fever finally break.

When Yes Means No and No Means Yes (Maybe)

Does this mean that stocks have bottomed? Or, at the very least, that it’s time to again take a harder look at long-side opportunities, from both a trading and investing perspective?

To be honest, I’d rather prefer you didn’t believe that. Well, okay, maybe not you. But as for the investing public at large – we’re better off without their agreement at this point.

I should probably explain…

In order for stocks to bottom, we need to see maximum pessimism. It needs to be thoroughly common knowledge just how bad things are, with everyone and their brother fully aware that things are “only going to get worse.”

This reality is precisely what makes it so hard to buy near the actual bottom. By the time the market gets there, positive sentiment is all but washed out. At the bottom, the true believers have all been converted to cynics.

This ironic sliver of market reality creates a paradox. If you were to go around taking a survey of investors asking, “Is this the bottom?”, the results of the survey would have inverse value.

The more investors who responded to your ad hoc survey with a firm “NO” – or better yet with a “what are you, crazy?” – the greater the odds would be of a bottom having been reached.

Hardly anyone trusts the first ascent from the pit. Everyone is half-waiting for the whole thing to break again. Coincidentally, that’s why professional traders and investors tend to get the best prices… they’re the ones who can steel themselves against queasiness and uncertainty when the odds tell them to act.

Bottoms Aren’t the Point

At this point I have to share a confession with you.

In spite of what the thrust of today’s piece might imply, I don’t really care whether the market has bottomed or not. And you probably shouldn’t either. Here’s why.

If you are a trader, you act based on odds and probabilities (or at least you should). Solid trades, like solid poker hands, are all about getting a handle on odds and reward to risk.

If the reward to risk is right – if the probability and the setup is right – then you take the trade. If not, then you don’t. Trading gains are accumulated over time in this fashion – with large wins overpowering small losses – just as pro poker players accumulate their winnings over an extended series of hands.

If you are an investor, you act based on valuations and long-term assessments of what companies are worth. Like Warren Buffett, you may not “time” things, but you do “price” things. A skilled investor has the habit of looking at a stock quote and seeing the actual value of the business behind it.

For sharp investors the question is less “How much are the shares really worth” and more “How much is the business really worth?” How good a shape is the business in? What kind of cash flows does it have? What kind of long-term potential does it hold? If I could get the financing and the go-ahead to buy this company outright and run it myself, would I want to do it?

Some of you are traders, some of you are investors, and some of you (like yours truly) have a consuming passion for both.

Either way, if you’re really focused on your process – on using all the tools you have available to make money – then picking “the” bottom doesn’t matter so much.

Why Talk About This Stuff At All Then?

Okay, some of you may be wondering now, if calling the bottom isn’t all that meaningful for the trading and investing process, why talk about bottoms then?

The reason to talk about this kind of thing is because there is real value (in your editor’s humble opinion) in analyzing the tone and tenor of market action.

It’s useful to get a handle on how the market is acting, just as it’s useful for a doctor to have means of checking the symptoms and vital signs in a patient.

The key differential comes down to purpose – it depends on what you do with the information you collect, and what your mindset is in collecting it in the first place.

Following market action with the goal of saying “I called such and such a move,” or to win an argument or bolster a pre-existing opinion, is one thing.

Dissecting market action with a cool, dispassionate eye – looking to inform the choices you make with a better sense of odds and probabilities – is quite another.

A Possible Inflection Point

What we’ve seen in the past few days, I believe, is a possible inflection point… a point in the cycle at which the news got about as bad as it could get, with credit spreads on investment-grade debt about as wide as they could be… and yet stocks shot up anyway.

I think, too, that we just might be in the midst of a psychological inflection point here.

After an extended nightmare of government dolts who screwed up at every turn, and banks that blew up every time a Wall Street CEO turned around, we are finally starting to get a handle on what tomorrow might look like.

Source: Source: The Perverse Logic of Market Bottoms

The fort must have sent shivers up the spines of all those who hoped to take it. The walls of El Morro are 18 feet thick and 145 feet high. Built on a headland, the Spanish Empire controlled the flow of goods in and out of the New World from here. El Morro has been tested many times. Even today, you can walk in the oldest tower in the fort, built in 1539, and see shell fragments in the ceiling that date to the 1898 bombardment of San Juan by the U.S. Navy during the Spanish-American War.

El Morro is a testament to the idea that in war, some things have not changed since Joshua gazed upon the walls of Jericho, or since Pericles sent the Athenian fleet against Sparta.

In investing, too, there are some things haven’t changed since those 24 brokers met under a buttonwood tree and started what became the NYSE. Buying low and selling high works in all markets. But this is easier said than done. As James Grant, editor of Grant’s Interest Rate Observer, points out in a recent letter: “We human beings only say we like to buy low and sell high. Our every instinct is to do the opposite. Rock-bottom prices only seem low in retrospect. At the time, they seem frightening because of the very reasons they are cheap.”

Such a time is now. And it is a sign of the kind of panic we are in. The investors who loved stocks one year ago when the Dow was hitting new record highs are the same investors who are now afraid to buy stocks, even though they are half the price they used to be. Successful investors buy when stocks are cheap and falling. Unsuccessful investors merely panic.

Let me tell you a little story that illustrates the point…

In July 1986, John Mendelson, a strategist at the brokerage firm Dean Witter Reynolds, was out fishing with his son. For whatever reasons, he decided the market would drop. And on Monday morning, at the next strategy meeting, Mendelson convinced 60 stockbrokers it was time to sell.

After the meeting, they rushed for the phones. (This was in the old days, before the advent of BlackBerries and the Internet.) Before long, the sell order rippled through some 600 institutional investors. The Dow Jones industrial average fell 62 points. This was back in the days when the Dow was barely 1,900. So it was a significant drop.

Lars Tvede tells this story in his The Psychology of Finance. It’s meant to show how one man could precipitate a meaningful drop in the market. It seems arbitrary, and it is. An investor in 1986 might’ve fretted at seeing his stocks in the red, but he shouldn’t have. The sell-off had nothing to do with his investments as much as it did with the hunch one man got while fishing.

Economist Robert Shiller has done some interesting work on the reasons people sell into declines like that one in 1986. In September, the market had another drop of 87 points. Shiller asked hundreds of institutional investors and large individual investors for reasons why they bought or sold during these times. Out of the 113 replies he received, none sold for any economic news or fundamental reasons that the press pointed out after the fact. Instead, “What was emphasized most,” Tvede writes, “was the market’s drop itself.”

After the big 1987 crash, Shiller sent out thousands of questionnaires. Again, the results were the same. The overwhelming reason investors sold was because the market was down.

This reminds me of that old Chinese saying that one dog barks at something and a hundred bark at the bark. Don’t be just one of the dogs that’s barking at the bark.

Source: Buy Low…If You Dare