3 Reasons Markets Could Rebound Fast

03/17/2011 1:55 pm EST

Focus: MARKETS

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

While stocks have corrected since doubling from the bear-market lows, there’s more gas in the tank, writes Bernie Schaeffer in the Option Advisor.

"The quickest way to double your money is to fold it in half and put it in your back pocket."—Will Rogers

A Google search for "double your money" returns 826,000 results, and "double your money in the stock market" is only slightly behind at 319,000.

So it is not surprising that when a stock doubles—or, in particular, a major stock index doubles—this attracts significant investor attention.

We have found that the increased attention associated with the doubling of an equity is often not of the kind that those who have been fortunate enough to be shareholders would prefer to attract.

Specifically, the stock price level associated with a double often becomes a "speed bump" or a resistance area, due mostly to the fact that many holders of the security decide it is time to take some or all of their investment off the table because...well, because it has already doubled, and could be vulnerable to a reversal of fortune.

Premature Profits
Of course, this type of "double and you're out" thinking can be quite counter-productive if you’re interested in a long-term investment strategy, in which achieving what legendary money manager Peter Lynch described as the "ten-baggers"—those stock plays that return ten times your original investment—is considered critical to success.

In fact, those who purchased Google (GOOG) on its first day of public trading in August 2004 achieved their double in less than a year—but if they sold at that juncture, they missed out on an additional 400% gain over the next two years.

Nevertheless, the realities of investor psychology must be recognized. The accompanying chart of the SPDR Gold Trust ETF (GLD) shows the returns since it began trading in November 2004 (along with S&P 500 returns).

chart
Click to Enlarge

Note that there was more than a year of hesitation in the otherwise steady rally by GLD after the gain had reached 100%, a double, in early 2007. (Also note the hesitation that has prevailed since the +200% level was achieved by GLD in late 2010— a "triple").

Next: What This Means for the Wider Market

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What This Means for the Wider Market
As you probably know, the S&P 500 Index recently reached its "doubling point" relative to its March 2009 low, only to pull back sharply.

Beyond the current period, we have seen a market double over 102 weeks on just two other occasions: 1934 and 1937 (and I'd note that 1934 was actually a good time to be invested, at least for a two- or three-year time horizon).

As colleague Todd Salamone noted recently, "1,333.58 on the S&P 500 is double the index's March 2009 low. For short-term traders, 1,333.58 is worth noting as a potential resistance or hesitation area.

“But longer term, we think the sentiment backdrop is one of much more investor caution and worry relative to 2007, implying the 'double-low' resistance could be a speed bump, at worst, and not a major inflection point like four years ago."

This leads to Todd's three reasons to remain bullish:

  • Plenty of cash remains on the sidelines that could still be deployed;
  • Portfolio insurance is actively being purchased, which makes stocks less vulnerable to panic selling when negative headlines hit the newswires; and
  • Short sellers are still actively engaged in the market—pressuring stocks, coincidentally, but providing short-covering potential in the future.

I agree with Todd's assessment that the current sentiment backdrop has bullish implications, yet to be fully realized. Cash on the sidelines has the potential to boost the market, once there is a significant catalyst to break the logjam.

And the sorry prospect of missing out on further gains, after the market has already doubled, might be just the ticket.

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