Heyer Capital, LLC

The general market (summarized here with the S&P500 ETF) has had a powerful up trend the past eight months. A peculiarity of it is the major trendline connecting the price action in March, July and early October.  To make it to new high ground (toward “Point A“), the market will have to pass through not only the natural doubting resistance of new highs but also up through the strong trendline.

Failure to press through toward “Point A” possibly sets us up for a head and shoulders reversal.

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.

Despite the relatively high number of days of institutional selling (signified by stock indexes down in price on higher volume) we should recognize that the market’s uptrend has resumed.

The bears have lots of reasons, but no one can argue with the tape (for too long, anyway.)

UPDATE: the sentence above seemed cryptic upon re-reading, so premit me to elaborate a bit.  We’re still facing several days of distribution in the past few weeks, so it wouldn’t take but a day or two of terrible action to again raise the “Yellow-Caution” flag on the market.   The DeMark indicators – a technical voodoo I don’t follow too closely – still shows meaningful ‘tops’ are in place for the S&P500 as well as some foreign currencies.  The English (& loose) translation is that any “Green light” means proceed with caution.

UPDATE: Oct. 28:  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.

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.

Last May, I cautioned blog-readers against investing in banks. Using the BKX as a general proxy, big banks had fallen about 30% from the peak;  Bear Stearns had been wiped out in March, big banks were reaffirming the dividends are safe, and the calls were being made: “January and March lows have held, so the bottom is in.”

But….

If you bought M&I Bank, or Lloyds, or Citigroup, or General Electric (a bank in drag) your investment is eviscerated. I mention those stocks specifically because I know from interviewing clients that area brokers were pushing those stocks.   Your broker gave you the sweet song of “juicy dividends” and “bank safety” and “buy and hold and cash the dividend checks”… and you just lost 50-80% of your capital and the dividends have evaporated.

In retrospect is seems it should have been obvious to anyone with just a cursory knowledge of economics:  banks were struggling for a mighty good reason: lack of un-impaired capital.

Sometimes the best investment is just staying out of the way.

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.

   One of my first posts on this blog  was a recession investing technique taught to me by a corporate CFO.  (The fact that I was warning investors of recession a year and a half ago ought to make you wonder if little ol’ me in the middle of Wisconsin could figure out the bubble was bursting, why couldn’t the bonus-bloated whiz kids on Wall Street? But I digress.)

   When fear is rampant in the credit markets, you’ll see the difference in yields between theoretically safe Treasuries and the low-rated “junk” bonds expand to more than 1000 basis points, or 10%.  As an example, the 10 year Treasuries might yield 3%, but the junk bond index would yield 13%.  

   Indeed, a Bloomberg article this morning described “armageddon” bond pricing, with the bond market assuming 5% of the corporate bonds outstanding will default, the highest failure rate since the first Great Depression.   That doesn’t mean prices can’t retract further, naturally, but we’re clearly suffering (or prepared to profit from) an enormous level of fear in the bond market.  

   Where to start? Find a bond fund with an indicated average credit quality of “BB” and “High yield” in the fund name.  Look at their latest statement of fund holdings, and have yourself a good chuckle at their hubris. “GMAC”?  ”Fannie Mae”?  ”Ford”?  Now watch the daily price of that fund. Do nothing, but watch. Is the price in a cascading waterfall?  Is the dividend yield up near 10%? Are more of their holdings defaulting?  Good. 

   Double check your risk fortitude, emotions, and time horizon.  How would you feel if the bond fund fell 20% from these already low levels?    The idea behind this method is to collect a juicy monthly dividend while riding up the price of bonds in a recovery.  You want to get paid well to wait.  You might even consider reinvesting those dividends right back into the fund, but keep good records for the taxman. 

  If your investments are at a no-load fund company itself or a 401k plan, when the time is right, consider starting to average in with price.  Consider making a small investment every week, or twice a week.    If your investments are at a brokerage firm selling high-commission mutual funds (sooooo 20th century) make him work for your business.   Mentally divide your investment into 20 equal sizes.  Tell your broker to make 15 investments over the next six months after your say “Go,” and he gets to pick 5 days to make a double-portion investment on days when the bond market is under extreme duress.  If he doesn’t know what that looks like, well…., enough said.     

   The concept is that this a one or two year investment horizon.  Watch from the sidelines as bonds default & miss interest payments and otherwise go to heck in a hand basket, buy-in gradually, collect the monthly dividends as the price of the fund improves as confidence returns to the bond market.  That is the best case scenario.

      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.