"Do you have the patience to wait until your mud settles and the water is clear? Can you remain unmoving until the right action arises by itself?" --Lao Tzu
Market players are always eager to declare that the worst is over after a good-sized bounce off an ugly trend. There were numerous comments over the long weekend about how stocks are now a great value and we had better hurry and jump in.
It is a very understandable reaction, especially in view of how quickly the market has bounced back from bouts of corrective action over the last six years. It is always the bears who end up looking a foolish when the market shrugs off what has been bothering it and resumes its uptrend.
The bears' response to this positive open is exactly what you would expect: They say that this time it really is different. We are returning to normality and this corrective action has a way to go before we can start talking about bottoms.
It is easy to scoff at that sort of pessimism. Pessimism hasn't paid the bills in a long time. We have always been rescued by central bankers and the computerized trading that dominates the market has consistently had a positive bias. The forces that move the market has conspired to make life difficult for the bears for a very long time.
So how do we deal with the market now? Do we take the optimistic view and look for a recovery to commence right away or do we adopt a bearish attitude and anticipate that the struggles will continue?
The best move is to simply stay open minded and make the market prove itself. A big bounce to start the week is not convincing proof that the worst is over; it is just routine movement in a market that has been under substantial pressure. It does not at all indicate that we have seen the lows and that it will be smooth sailing.
We have heard it quite a bit lately but it is worth repeating: the biggest bounces come in the worst markets. We will always see big moves that produce a sigh of relief and a ray of hope when we have suffered as we have in the first 10 days of the new year. The bulls will have a long list of statistics that will point out how the chances of bounces are quite high and the bears can't help but feel that maybe they have pressed their bets too hard.
The most important thing to keep in mind when dealing with a market in this position is that you don't need to be 100% long at the exact moment the market turns. If the market truly has found a low and is turning up, there will be plenty of time to put capital to work. In fact, it will take more than a gap-up open to start the week to produce decent charts. There are very few setups and that isn't going to change with just one or even several days of good action. We have suffered ugly damage and that takes time to repair but, to make it even harder, we can't be at all confident that the downtrend has ended.
This market has to prove itself. This open isn't a sufficient basis to shift from a bearish to bullish bias. If you caught the move, be ready to claim your gains but don't start celebrating the end of the correction.
The market has undergone a correction so far, but the character of the action has changed significantly and we need to be much more careful than we have in the past. The price action is the ultimate guide to the health of the market and this open isn't going to be sufficient to change the course of the action.
We have a bounce in oil, hope that the weak growth in China will produce more stimulus, cuts in global growth from the International Monetary Fund and the kick-off of earnings season this week. There are plenty of catalysts to produce volatility, but little basis to believe that we have hit bottom. Don't be in a big hurry to put your precious capital at risk.
