Try to Stay Selective

 | Oct 12, 2012 | 8:17 AM EDT
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Distrust and caution are the parents of security. -- Benjamin Franklin

The first major third-quarter earnings reports, from JPMorgan (JPM) and Wells Fargo (WFC), are hitting this morning and next week we have dozens of important reports. The big question we now face is whether earnings will be the catalyst that helps this market regain its footing or will they be the catalyst that accelerates the downtrend that has been developing?

The bulls argue that everyone already knows that earnings are likely to be a bit soft due to worldwide economic weakness and it has already been priced in to the market to a great degree. The bulls are hoping that we will see a buy-the-bad-news reaction or that we simply won't see much additional pressure when mediocre numbers hit.

The bears argue that it is wishful thinking to believe that the market has already priced in a poor quarter and soft forward guidance. Although we have corrected a bit over the last couple weeks we are still near the highs and sitting on substantial gains. While there has been much talk about how it may be a challenging quarter, that is not fully reflected in the price action.

The way the market has acted over the last three days reflects a very high level of concern. The bounce try yesterday fizzled out quickly and we closed around flat, which is fairly unusual for a market that has consistently seen aggressive dip buying after a few days of weakness. Failed bounces are typical when the market is undergoing a correction and the action yesterday certainly qualifies as a disappointment despite the shallow losses.

Market players need to decide whether they are going to respect the fact that the market action has deteriorated lately or are they going to be that it will be forgotten and we'll jump back up quickly. My bias is to always respect the price action and, as I've been noting for a couple weeks now, I see evidence that a topping process is taking place. My belief is that it is we need to respect that and wait for the market action to improve before we become more aggressive with buying.

The other school of thought is that is that weakness is a buying opportunity and if you don't rush in and buy you will miss out on some great opportunities. I don't believe that. I don't believe that you are going to be at a disadvantage if you aren't fully long at the precise moment the market turns.  Even if you could time that just right, those who are a little late are not going to miss out on much. More often than not, the folks who are so anxious to buy a weak market will have to make up some big losses before they are back to even. The bottom fishers are almost always too early, but they conveniently forget that fact when the market does bounce.

Next week, as earnings reports roll out, we will have a better feel for the market mood. Typical a theme will start to develop and we'll see bad reports being bought or good reports being sold or whatever. JPM will be a good test today of the mood and so far it is trading higher.

This is a market environment that demands caution. We need to protect capital about all else, but there should be some trading opportunities in the short term.  The bounce buyers were burned yesterday, but they will try it again and we'll have some volatility to embrace.

We have some slight positive action in the early going, but the early chasers are likely to be a bit gun shy  after yesterday. Stay selective with your trades and manage them tightly.

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