This Action Is Long Overdue

 | Apr 07, 2014 | 4:16 PM EDT
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Bad markets don't scare you out, they wear you out -- and we had a taste of that sort of selling today.

The market managed a little bounce for about an hour as the day wound down, but sold off again in the final 30 minutes. Basically, we saw steady selling all day with very limited dip-buying. The dip-buyers -- who couldn't be deterred when the action was running straight up -- have lost their nerve and are standing on the sidelines. They want no part of this action.

My biggest concern about this market is how the DJIA and S&P 500 have not reflected the extent of the damage that has been done. It is not likely that we will make a good low until the senior indices catch up to the downside to some extent. If the Dow or S&P were down as much as some of the momentum stocks, we'd be seeing blaring headlines about bear markets and crashes. The average stock has already undergone a decent correction, but we aren't getting capitulation or extremes in sentiment because too many people are lulled by the mild action in the DJIA.

While this action is painful if you lugging long inventory, it is overdue and ultimately will be a positive. Healthy markets need periodic corrections and that is what helps traders produce superior returns. The buy-and-holders have grown overconfident but now the pendulum is swinging in the other direction and traders will have their opportunity to outperform.

The market is clearly in a downtrend and we need to respect that, just like we respected the price action when the market trended up for so long.

Have a good evening. I'll see you tomorrow.

April 07, 2014 | 1:59 PM EDT

Watch Out for Stuck Bulls.

  • Meanwhile, I'm waiting for the selling to play out.

It has been a long time since we have seen action this poor. What is most significant is that bids have just disappeared. There is no interest in trying to snap up "bargains." Fundamentals and valuation are irrelevant, although we will hear more analysts and pundits use the phrase "buying opportunity."

I suspect many market players have forgotten what downside momentum feels like. We were rewarded so often and so consistently for immediately buying any dip that many have likely been caught trying to play that game again.

I have no interest in trying to catch stocks that are in free-fall. We will see a big bounce at some point, but trying to guess when is impossible. An oversold market like this has a tendency to become even more oversold.

The biggest bounces occur within downtrends like this, but bounces have a greater tendency to fail when he market has fallen in this manner. This sort of action creates many stuck bulls who are happy to escape into strength as bears reload. That is why bounces within a downtrend usually don't turn into V-shaped moves.

I'm doing nothing as I wait for this selling to play out. I see a number of things I'd eventually like to buy, but I don't know if that will be tomorrow or next week.

Starting the day my accounts were not very far off their all-time highs. I'm down a little bit more today and I'll sell down some things before I let them slip much more. In a market like this my goal is to keep accounts as close to highs as possible. That is the key to exceptional performance over the long term.

April 07, 2014 | 10:45 AM EDT

Playing Into Sentiment

  • Washing out weak holders sets up better conditions for a bounce.

Over the past couple of years the market has had a strong tendency to gap up on Monday mornings, so it was refreshing to see that sentiment was actually negative enough to produce selling in the early going today. I'm sure there was a long line of bears and trapped bulls eager to sell into a gap. Instead, weak holders were washed out to set up better conditions for a bounce.

The important thing in a market like this is not to confuse a bounce with a bottom. There is no reason to believe we won't be hit with another wave of selling, especially as margin calls take their toll. But short-term countertrend bounces are a great way to play the emotions that exist in a market like this.

The two stocks I've been keying off as my indicator of sentiment are Facebook (FB) and Tesla (TSLA). Both opened weak and then turned green as traders jumped in, but they are seeing pressure from flippers pretty quickly. When the pressure on momentum does relent, I expect these two, along with Google (GOOG, GOOGL) to be the main go-to names.

I'm doing a few small buys for quick intraday flips and I'm not in any hurry to build up positions. Some of the small-caps I want to build as they find support include BioTelemetry (BEAT), Quantum Fuel Systems Technologies Worldwide (QTWW) and Sky-mobi (MOBI), but none of them have any decent support right now.

Keep in mind that the goal isn't to buy stocks just because they are lower. The goal is to buy them when they have the best chance of making a sustained move. Too many folks focus on calling bottoms and that doesn't make for the optimal trade entry.

April 07, 2014 | 8:20 AM EDT

No Reason to Believe the Pullback Is Over

  • Still, I don't agree with the 2000 comparisons.

"The aim of the wise is not to secure pleasure, but to avoid pain." -- Aristotle

Over the past couple years, the market has consistently punished traders who have taken defensive action at the first sign of trouble. Just when it looked as if the market was about to undergo a more significant correction, it would reverse and climb straight up, making any bears out there feel rather foolish. Each time the bible of momentum trading, Investor's Business Daily, has declared that the market has been in a correction, the market has found a bottom within a few days. Not only have the indices always bounced, but they've gone right back up to new highs.

Is it different this time? It is said that those are the most dangerous words in investing, but this action does feel different. It is inevitable that the market will eventually undergo a relatively dramatic correction after the past couple of years, during which it has suffered hardly any dips. It is the nature of the beast for it to occasionally shake us up, and there definitely are some blaring warning signs at the moment.

The big difference this time is the rotation that has been occurring under the surface. The headline S&P 500 and Dow levels haven't at all reflected the turmoil that has been going on for a couple weeks now. Many momentum stocks have already undergoing a very substantial correction. The bullish spin on this is that many of those stocks had been frothy and had carried unsustainable valuations -- and that, therefore, it has been a good sign that money has rotated into defensive and value names. This argument says that the recent action constitutes nothing more than a healthy shift in leadership, and that it's no cause for great concern.

I, however, have strongly disagreed with the view that this rotation is a healthy thing. Stocks such as Microsoft (MSFT), Intel (INTC) and Johnson & Johnson (JNJ) never lead the market for long, and when they do well it's usually a sign of topping action, rather than of the second wind of an uptrend. Good markets are always led by high-beta stocks, and those are all being slammed right now.

On Friday, market players suddenly seemed to start taking the view that the growth and momentum names are likely to pull down the defensive and value names, rather than vice versa. The senior indices finally started to reflect some of the ills that have been plaguing the broader market for a while.

The big question we face this morning is whether this is the start of the first real broad correction we have seen in quite some time. Many folks have been comparing the recent market action to that of 2000. I've never cared for those sort of historic comparisons, and this one in particular seems questionable, since there are so many differences between then and now. If you traded back in 1999 and 2000, you know the recent mood and sentiment have been not at all comparable to what we saw back then, and some of the crazy valuations at that point weren't even close to the most extreme multiples we are seeing now.

While I wouldn't be at all surprised to see a correction of more than 10%, I don't think such a pullback will end up being the sort of turning point that we saw at the top in 2000. At this point it doesn't really matter anyway. What is painfully clear is that, until the action shifts, we as traders need to take some defensive action and make sure that we protect our capital.

It's a funny thing about the market. It can make you feel like a fool when you are too quick to be cautious, yet when you decide you won't be tricked again and give up your usual discipline, that is the time when the indices fail to find support and quickly reverse.

Playing defense carries a cost but, as I've often written, it is better to think of it as a cheap form of insurance. You pay premiums and don't make any claims but, eventually, when you do need it, it will save you some significant money.

The key in the market like this is to not get sucked into the bottom-calling game. Raise cash, don't be in a rush to jump back in and respect the downward momentum. If you protect your capital and keep losses contained, you can easily have your portfolio back at new highs very quickly.

We shall see how it goes but, at this point, I see no reason to believe that this correction is over.

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