The Danger of Failed Bounces

 | Apr 25, 2014 | 4:10 PM EDT
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The essence of market downtrends is failed bounces. The bounces build confidence and cause the optimists to put money to work, and then the action like we had today traps the bulls and crushes their hope. Each bounce attempt is trusted less until the bulls give up even trying, and that eventually leads to the market low.

In this market, failed bounces are even more dangerous, because we have had so many V-shaped recoveries. If you haven't embraced the bounces, you have been left on the sidelines as they continue higher.

The seven positive days in a row that we had over the last couple weeks provided a good example of how market players have been forced to embrace questionable technical action. It was obvious that volume was lackluster and that we didn't have very good leadership, but none of those very reasonable concerns mattered back in February or last year, when the market would recover in a straight line.

The end result is that there are probably more stuck bulls as a result of this pattern of V-shaped bounces. Many are still hoping that the selling today will quickly blow over, but if it doesn't, it will be a painful process as they look for a way to escape.

The good news is that there is some technical support out there. The SPDR S&P 500 (SPY) bounced off its 50-day simple moving average within a few pennies, and the Russell 2000 (IWM) isn't far from its 200-day simple moving average. The bad news is that these support levels don't look very strong and can fall quickly with one more bout of selling.

One of the bigger problems we face is that the Dow Jones Industrial Average and S&P 500 have barely corrected, while many Nasdaq and small-cap stocks have been pounded. It is going to be tough for the market to make a good low until the senior indices catch up a bit to the downside. The DJIA is probably keeping sentiment more positive than it should be, and that prevents a better washout.

As I noted this morning, I have declared myself to be a bear. The action today simply confirmed that viewpoint.

Have a great weekend. I'll see you on Monday.

April 25, 2014 | 10:32 AM EDT

Just Be Patient

  • This unpleasant action will eventually lead to a better market.

The market action this morning can be summed up as dismal. It isn't screaming lower but there is steady selling across the board. Precious metals and oils are exhibiting a little relative strength but momentum stocks, biotechnology, small-caps and most key sectors are not seeing any bids. All those dip-buyers who could barely wait for a downtick back in February have disappeared.

As I stated in my opening post, I'm calling myself a bear for the first time in a long while. That doesn't mean I'm betting on a major meltdown, but I have raised substantial cash and have no plans to do any position building right now. There are still some stocks that I think have potential for the longer term but I see no reason to start buying them at this time.

The biggest mistake many bears make is that they start to buy too early as they hope to nail the exact moment the market makes a low. The key is to buy when momentum shifts and that doesn't necessarily correspond with a market low.

I've taken more stops this morning and am now about 90% cash. My accounts are less than 3% off all-time highs, so I feel that I am positioned well to deal with a rough patch.

This action is not very pleasant but it is necessary and will eventually lead to a better market. We just need to be patient. 

April 25, 2014 | 09:09 AM EDT

I Am Now a Bear

  • I'm going to protect capital and stay lightly invested.

"No sense in being pessimistic. It wouldn't work anyway," -- Cathie Linz

It isn't my style to declare market tops or bottoms, but after the action yesterday I'm declaring myself a bear.

That doesn't mean that I expect the market to suddenly collapse and that we will suffer action like we had 2008 and 2009, but I expect it to be a very tough slog for a while. It is going to take some hard work to make progress.

There are number of reasons for my pessimism. First, the market has not reacted well to some pretty good earnings reports. Both Apple (AAPL) and Facebook (FB) posted good numbers, but the news was immediately sold. We did bounce back and the close wasn't that bad, but the underlying action was uninspiring at best.

Ultimately, my view of the market always come down to the price action in individual stocks. Even in the worst market, there will be a few stocks that act well, which will cause the bulls to excuse a host of sins. But a few safe harbors doesn't make for a good market.

I see two major problems with this market.

First is the lack of leadership. We still have some stocks making new highs and oil-related names in particular have done well, but there is no clear leadership.  Strong markets are led by stocks like Google (GOOG), (AMZN), Facebook, Tesla (TSLA), Netflix (NFLX) and so on. 

Yesterday, we had nearly 250 stocks making new highs, but you'd be hard pressed to say there was some sort of clear theme. Caterpillar (CAT), Skyworks Solutions (SWKS) and Micron Technology (MU) are a few that stand out but they aren't taking other stocks along with them. Leading stocks need to lead and that isn't happening.

The bulls will argue that there is nothing wrong with this market. Just look at that six-day long, V-shaped bounce that has the S&P 500 almost back to its all–time highs. Nothing about this market has changed, they will tell us.

Unfortunately, the V-shaped bounce this time didn't have the same breadth or power as prior ones, such as the one in February. Stocks like Tesla and Google barely budged and the small-cap indices never even made it very close to the 50-day simple moving average. The stocks that had been hit the hardest in the correction that started in March did not come back and that is a good reason for concern.

Over the last few years, this market has done a great job of making bears feel foolish. Over and over we shrug off the negatives and come roaring back as if nothing has happened. That can certainly happen again, but the market is acting differently this time and I'm mentally preparing myself to deal with a tough environment.

I'm going to keep looking for stocks to buy and will be happy to change my mind if conditions change. But right now I don't like this market and I'm pessimistic about action in the short term. I'm going to protect capital and stay lightly invested until conditions change.

At the time of publication, the author had no positions in any of the securities mentioned.

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