In a World of Pain

 | May 08, 2014 | 4:10 PM EDT
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While the DJIA continues its ridiculous ascent, the "real" market was in a world of pain today. What was particularly disappointing was the hint of promise in the early action when momentum, speculative and small-cap stocks bounced. This turned out to be a "suck-in" trap for the bulls, who were quickly stopped out as the action turned negative in the afternoon.

Many folks associate bear markets with sudden one-day crashes, but the real pain comes in the prolonged downtrends when the action grinds slowly and steadily lower. The iShares Russell 2000 (IWM) is undergoing that process right now as it cuts through support at the 200-day simple moving average for the first time since 2012. It has been downtrending for more than two months and is far more representative of the average stock in this market than the DJIA.

One of the biggest problems in a market like this is that it is very unforgiving if you make a mistake. In a good market, you will often be bailed out of a bad trade, but in an environment like this, you can suffer an endless number of small hits that eventually take a sizable toll.

When the market is downtrending -- regardless of the DJIA -- there is one simple thing to do: Get out of the way. Our job in a poor market is to protect capital so we can be in a good position for big gains when things improve. Not losing money is a major accomplishment. If you can do that in this very poor market, you will be in good shape for the long run.

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

May 08, 2014 | 1:35 PM EDT

A Stumble in the Bounce

  • I'd like to put idle cash to work, but I see little of interest.

This morning's bounce is starting to stumble, particularly in the small-caps, but the majority of momentum names I follow are still solidly in green. It is better action and I'd like to put idle cash to work, but I see little of interest and I'm definitely going to take my time.

As a trend-following momentum trader, I'm very aware that I'm going to be underinvested in the early stages of a market recovery. Moving into cash at an early stage of a market correction more than makes up for it, but it is always a challenge to rebuild my holdings once the market starts improving. I suspect many folks end up using a buy-and-hold strategy simply because they don't want to be constantly looking for new ideas. When you move in and out of the market, the key to success is to make sure you have a good supply of new ideas.

What is always tricky during downtrends is distinguishing between an oversold bounce and a major turn. You simple can't tell the different after just a day or two of action. What ultimately provides comfort that a good low has been made is that support levels hold and bounces don't fade quite as much.

Too many market players are obsessed with the idea of being 100% long at the exact moment the market makes a low. I suspect they end up having to recoup sizable losses when they play that game. I'm not convinced that this market will hold, but I'm staying open minded and will look at buys if there's a strong close. Things are looking a little precarious as I write, so I'm not feeling too bad about not finding much to buy.

May 08, 2014 | 10:43 AM EDT

Momentum Names Pick Up

  • Many of these names are due for an oversold bounce.

It looked like Tesla (TSLA) and Priceline (PCLN) were going to lead momentum stocks to the downside again, but we are finally seeing relief bounces in the hardest-hit names. Breadth is a sold 2-to-1 positive and Netflix (NFLX), Facebook (FB), Chipotle (CMG), SolarCity (SCTY) and Google (GOOGL) are finally showing signs of life.

The big question is whether the momentum names and small-caps can bottom after a sizable correction. Or do the DJIA and the defensive and safe stocks have to come down before we see a good low?

I've been skeptical of the ability of the momentum and speculative stocks to turn up without some sort of hit to the senior indices first, but buyers seem to be tired of waiting this morning. Many have no interest in buying the big-cap defensive names, so they are sticking a toe back into the momentum favorites.

Many of these momentum names are due for an oversold bounce, and I'll give them room to do that, but it is going to take more than a one-day bounce to put them back on track. A better market has to start somewhere, and I'm hoping that the selling pressure will relent.

May 08, 2014 | 8:04 AM EDT

Finding the Secret Correction

  • You have to dig deep to know one is occurring.

You'd be surprised what poison is often hidden in the most beautiful camouflage.--Evelyn Klebert

Market corrections usually result in blaring headlines and worried commentators. Reporters will tell us how much the DJIA has been hit and report that it is the biggest loss in months or years. Fear grows and many market players rush to sell before things become even worse.

The current correction is playing out a bit different. In fact you actually have to do some digging to even know that one is occurring. The DJIA and S&P 500 are hovering close to their all-time highs after a bit of a boost from Janet Yellen, but under the surface the majority of stocks continue to act poorly.

What the indices are not telling us is that the 'average' stock is down 10 to 15% from the highs, which occurred in early March. Many momentum names have corrected 25% or more and the small-cap indices are down 8% to 9%.

There has been significant corrective action in the majority of stocks. But you simply wouldn't know it if you just scan the headlines and look at the useless DJIA that the media loves to promote. Sentiment has hardly fallen at all because so many folks are blind to the poor action under the surface.

This disconnect between the NYSE and Nasdaq was particularly striking on Wednesday. Breadth on the NYSE was almost 2 to 1 positive while it was negative on the Nasdaq. Momentum stocks, which make up the IBD50, lost 1.2% while the S&P500 gained 0.6%.

The bulls shrug at this inconsistent action and tell us that money is rotating. We just need to buy some different names if we want to profit from this great market.

Maybe that is true. But the big issue for us to ponder is how does this secret correction continue to play out? Do the stocks that have already been hit the hardest find support and start trading up along with the defensive stocks that have been holding up the indices? That is the most bullish scenario.

The view is that many momentum and speculative stocks simply were overheated and needed to cool off. While that has happened money has rotated into safer, more conservative names, and now the market will be fine that we have squeezed out the excesses.

The pessimistic view is that this rolling correction is still rolling and it is a mistake to think that more stocks won't eventually be impacted. Markets are never led by defensive names for long. Either the growth and momentum names come back and lead, or the rest of the market falls to the pressure and a broader correction takes place. McDonald's (MCD) and Wal-Mart (WMT) are not the sort of stocks that are going to be leading the market higher for months or years.

This secret correction is causing a huge amount of frustration for traders who tend to favor the stocks that have been suffering the brunt of the selling. Tesla (TSLA) is a good example and is breaking down even more this morning following a mediocre earnings report. Social media stocks, which traders loved a few months ago, now look like death.

It is obviously a market that requires astute stock picking. But the hardest part is that most of the stocks that are holding up the indices aren't very good trading vehicles. The buy-and-hold folks love the fact that the stodgy, conservative names are acting so well, but for the hot money traders this market stinks.

We have a very flat open on the way as we await some economic reports and digest earnings. With the DJIA ready to make new highs why would anyone even use the word 'correction'?

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