Heyer Capital, LLC

The character of the market this fall has been for the uptrend to fall under pressure, but inch up into newer highs. Once it makes new highs for the move, the rally – by definition – has resumed again. The sloppy action among the market leaders and the weight of the many distribution days has been too much and the market is now in a correction.

Remember, a ‘correction‘ can last a few days or a few months. Be patient. Read & research.  Build the watch list.

“Corrections”  don’t mean the market will plunge 60% in the next week. It’ll take six months. Just kidding!   Given that IBD research has shown that 3/4 of stocks follow the general trend, it will likely be difficult to make headway in your stock or mutual fund investments against the downtrend.  I understand that sounds like I’m saying, “You’re going to get wet when it’s raining.”  Instead I’m encouraging you to plan your next picnic when it’s raining so you’re ready to go when it stops raining.

“Investor’s Business Daily” founder Bill O’Neil provides an insightful interview on KOA radio earlier last week. Here’s the link if you need browsing background-sound.

http://www.investors.com/MediaCenter/default.aspx?mediaID=482737

The three key take-aways are that 1) he believes a new secular bull market began in March; 2) tune out Wall Street noise and predictions from the overeducated talking head. Discern what the facts of the market tell you;  3) entrepreneurial America will thrive, regardless of Washington’s follies.

One of the defining characteristics of a Follow Through Day is the strength of leadership shown by quality growth stocks.  You want to see solid companies leaping ahead of the market, advancing on higher volume. 

Ryan Krueger of Krueger & Catalano Capital Partners posts that out of the top 25 performers last week out of the entire S&P 500, how many were non-financials above $10 per share?   Exactly zero.

If we hold together through the market close, today should qualify as the follow through day of the rally beginning from the March 6 lows. 

The “follow through day” is a day of heavy percentage gains in a major index accompanied by heavy volume and leadership from quality growth stocks.  To qualify, it must come on or after Day 4 from the market bottom. (IBD research shows the most common follow through days come on Days 4-7.)

This is not a raw “buy” signal. We’re in a bear market; all rallies must be treated with suspicion.

I sometimes get puzzled responses when I relate “Investor’s Business Daily” founder, Bill O’Neil’s, market aphorism that “All stocks are bad, until they’re ready to go up.”  A corollary saying is “Just because you like the company, doesn’t mean it’s a good stock to own.”  Case in point, Apple Inc.

In the past several years, Apple has been an enormous commercial success with its iPods, innovative computers, and iTunes. It was a tremendous cash-generating machine with outstanding earnings growth and a solid balance sheet.  In 2007, shareholders were handsomely rewarded, as the stock leapt from a ‘cup with handle’ technical pattern in April 2007 giving stock gains over 100% for the year. It culminated with a Christmas price peak over $200 that has not been overcome.

AAPL carved a deep base in the first few months of 2008, dropping over 40% from Point A to Point B.  It’s normal for high beta market leaders to correct more than the overall market, but 40% is about the maximum decline that’s acceptable in building a base digesting big prior gains.   AAPL charged up from B to C, and formed a typical consolidating handle.   The proper buy point at Point C, but only if the stock charges past C in heavier volume.  Waiting for such a movement, and not getting in too early,  puts the odds in your favor of fresh gains.

Why not try to get in earlier and try for bigger gains?  Look at any price point after C.  That, in a picture, is why.  It may indeed rally from Point D, but any price gains have to chew through all of the holders that bought in the prior two years at prices from $100 to $200 that will sell as the price advances.  Any stock gain is hindered by a flurry of orders of “Just get me out at what I paid.” That’s a textbook picture of upside resistance, particularly given the number of novice investors flocking to a brand name such as AAPL.  

Why bother buying stocks that have to fight battles through the next $100 in price?  Keep the bulk of your powder dry until the odds of success are in your favor.

      Today’s price action is a higher-volume follow through day on the rally starting after the horrendous Oct 10.  As I’ve noted previously, bear market rallies are quick, vicious, and exhilarating.  Do not fall in love with your stocks again, as the longer term down trend remains in tact.  My greatest concern is the lack of leadership in the past couple of weeks.  Which sector is going to rotate to the front of the pack?

      Brian Shannon at AlphaTrends.blogspot.com has published some outstanding data to help us put perspective on this market.

Here are a few valuable market aphorisms: 

Opportunities are made up easier than losses. 

All stocks are bad, until they are ready to go up [according to their chart pattern.] 

A falling market is guilty until proven innocent. 

Don’t try to catch a falling knife. 

The trend is your friend (the down trend is your enemy.) 

“Bottoming” is a process, not a day.  It takes price and time.

Only one person gets to “invest like Warren Buffett.”

There is wisdom in multiple counselors.

I thought this anecdote might shed some light on the market swings, and how bad it was mid-day. 

As I write this, the US markets managed a meager gain to day after finishing the worst June since the Great Depression #1, the Nikkei is suffering its 10th straight down day; the S&P oscillator is pegged at -9, the lowest reading; the market’s Mad Money maven Jim Cramer says M&I bank won’t survive; and market commentators are beside themselves with doom and gloom.

The contrarian in me says, Damn the torpedos. Full Steam ahead!  But that would be too clever by half.  The market is weak for many good and proper reasons. I’ll let you, dear reader, flesh those out for yourself.  Instead I encourage you to wait for a follow through day showing a new rally has possibly begun.  

Why wait?  Right now the market trend is down. And “price pays”.  Price is the only thing that matters. Having a boat load of statistics and oscillators at your back doesn’t mean anything if the price action is lower, leading to losses.  The market sets the price, and price pays.  

How will you recognize a rally follow through day?  It will comes generally  4-8 days after an intermediate market bottom, and a couple things will happen:  1) broad indexes will advance at least +1.8%; 2) on heavy volume; 3) with many leading stocks advancing on good volume.  Ken Shreve, the markets editor at IBD, said in an interview recently that the follow through day is the correct entry point 3/4 of the time according to their century’s worth of data.  (Think market timing is gambling?  Find a casino game with 3:1 odds in your favor.)

Of course, don’t jump in with all capital right away.  Keep your watch list pruned now. Which stocks have really held up well the past month?  Are they finishing in the top of their weekly price ranges?  And for goodness sake, keep stop losses tight, especially cutting losses at 8% or less to avoid big trouble. 

Stock market caution is warranted here.  Folks should sit up and take notice whenever the Dow sheds 500 pts in two days.   But two days do not make a robust sell signal. Let’s look back a couple weeks for perspective. 

In this chart the S&P 500 has logged several distribution days in recent weeks, and they are marked with arrows. (Distribution days occur when the markets close lower in price, with higher trading volume. Action of leading stocks will color & nuance the analysis, so it’s not a black and white definition. YMMV.)   The intra-day reversal on May 19 (climb into movement highs on weak volume, then faltering and falling) at Point A was another signal for caution.  The May 19 action combined with the May 2 prior movement top give us a double top to work through before an advance can occur. 

Don’t hesitate to leave a comment or drop me an email if you have a question.