Skeptics To The Ramparts: How Bull Markets Are Formed From The "Prince Racquet" Effect Until The Momentum Favorites Get Tired

A correspondent writes in,

My good friend CP and I spend a great deal of time discussing the problem that we share as two cynical contrarians, namely how to restrain our bearish enthusiasms in the face of investor euphoria and avoid the performance killer of being early. Valuation metrics don't help the timing problem. Witness the plight of that analytical genius John Hussman who keeps losing his clients money in his growth fund as overvaluation continues and increases for years on end. Similarly, the standard sentiment measures like Investors Intelligence, Market Vane and AAII measures of optimism hit extremes many times during a prolonged market rise. They may increase the odds for a short side swing trade for 5 days or perhaps 3 weeks, but the false positives for a full fledged bear market are too numerous. Who can forget the glaring signs of impending doom back in mid 2007 and the painful wait for a year and a half until September of 2008?

What we need is a sentiment indicator that has merit for longer term bear trades – one that keeps us long during periods of delusional optimism and urges us to exit just before the inevitable peak and endure only a several month wait until the bear attacks. We want an indicator that will allow us to gloat and quickly double our fortunes by being short at the right times and then go long and snooze for 4 or 5 years as the selling climax reverses and we go long the new momentum favorites.

CP likes those distressed debt trades where the bonds are selling at 60 cents on the dollar indicating bankruptcy is inevitable while the stock investors think the common stock still has value. These are good trades, and yet I and most other bearish investors have weaker egos that need the satisfaction of seeing the mighty fallen and the massive hordes of hipsters and momentum stock fanboys humbled. And more important, you make the most money staying with momentum stocks long, and shorting at the right time. And for that we need a sentiment indicator that is relevant to the dominant psychological driver of market euphoria. I have a theory that bull markets are created and maintained not by valuation but by momentum and herding.

As a young man and a new associate at the largest law firm in the state in 1974, I began playing tennis (not too aggressively) with some of the partners and discovered that they all had purchased aluminum racquets with the ugly, oversized head and striking surface from a company called Prince Racquet. Being a stock market investor at the time I looked up the company and found that it had an astronomic PE multiple (by 1970s standards) and I knew that the stock would plunge back to earth once sales slowed. Thereafter I noticed that stocks that produced whatever new gadget, fad or thing that filled the yuppie's hands tended to fly to the moon. I called it the Prince Racquet effect, a syndrome which tends to produce momentum surges beyond all reason. It drove Microsoft in 1995 (windows 95) and it now drives Starbucks, Apple, Google, Amazon, Netflix, Facebook, Twitter, Priceline, Chipotle Mexican Grill, and every other provider of things and services that fill hipster and yuppie hands or engages their eyes and fingers, or occasionally exploits their hopes for eco-nirvana as in the case of Tesla motors.

The Prince Racquet effect has always informed my short sale preferences. Thus I am now entirely reliant on my young adult daughters to tell me what is new and hip. And I must say that the Prince Racquet effect has gained considerably more power now than it had pre-1990. Items which fill the hipster-yuppy hand are now not merely fads, but are essential emblems of identity and recognition for the increasingly atomized, anonymous and disconnected individuals of today, herded by what they hold in their hands and use in their lives.

So then here is the candidate for the one reliable sentiment indicator - one which does not involve opinion surveys but relies on actual money flows into the Prince Racquet effect stocks.

I think that when you see momentum loss on the weekly charts of the most talked about moment stocks – the fad stocks and cocktail stocks that are most susceptible to investor herding - you have reason to go to cash and wait for THE TOP. And when I say momentum loss I mean a lower high on the weekly MACD even as price may still be rising. Click on the links for the following momentum favorites that are losing their mojo:

AAPL
GOOG
AMZN
NFLX
SBUX
PCLN
FB
TSLA

and one daily chart of a new entry, TWTR, consistent with the above but lacking the weekly time discipline.

It is one thing for a single company to fall from grace due to a company specific problem, but when you get a cluster of decade long momentum favorites getting tired at the same time the odds on bet is to sell all your long positions and begin nibbling at the short side to make sure you stay awake while stalking the big cahuna to the downside. My suspicion is that the value of or productivity of advertising is beginning to fall and all of the search and social media stocks will fall as ad revenue declines in response to decining productivity of those ads to retail sellers. Also, I think that a company like PCLN will get clobbered from both sides as fewer travel bookings are made by consumers and businesses tightening their belts and by fewer airlines and venues offering discounts as they struggle to maximize full price revenue from those who can still afford to travel. And for all its profitless sex appeal, AMZN is, after all, still just a retailer. For those of you who like busted “redneck” momentum stocks, I would invite you to plug the symbol RGR and SWHC. And for those of you betting on the momentum favorites among the “rising poverty stocks” plug in DLTR and ROST

Skeptics to the ramparts!!

By the way, last week Prechter put out a one page bulletin saying simply: "THIS IS IT".