As we wrap up one of the worst months for the market in many years the market mood finally is improving a little. The primary catalyst is that market players are starting to believe that bad news is now fully priced into the market. Facebook Inc. (FB) is trading up on a mediocre earnings report and even General Electric Co. (GE) has a buy recommendation from an analyst who believes it can't get any worse.
A reprieve from the misery of October shouldn't be a big surprise. Stocks were down 16 of 22 trading sessions so far this month, which hasn't happened since 2000. The technical damage has been broad and severe. There has been no place to hide and it has been particularly difficult for market players who have tried to find refuge in stocks they believed to be good values.
Although the mood is better this morning it would be a mistake to believe the worst is over. Bear market rallies are always the most energetic as they raise hopes and induce us to believe the misery has come to an end.
While it is possible that we have seen a low in the indices that will hold, that isn't the smart bet. We must proceed with caution and make stocks prove themselves. When the market action is as bad as it has been we should not be too trusting. This sort of action creates a large supply of trapped bulls who are looking for exits. If they can cut their losses they will be happy to rid themselves of the stocks that have caused them so much anxiety.
Quite often in the past few years the market has produced V-shaped bounces and gone straight back up with barely a pause. It happened so often that it undermined the traditional beliefs about technical overhead and resistance.
The brutal selling of the past month probably has destroyed the forces that produced these V-shaped moves. There is a major shift in the dynamics that are moving the market and volatility is likely to continue at higher levels now. There are still very powerful computer algorithms jerking the market around, but the programs have shifted to deal with the change that has occurred in the last month.
A big positive that has developed in the last week is that small-cap stocks have started to find good support. The Russell 2000 ETF (IWM) has outperformed over the past five trading sessions and has held up very well while the Nasdaq 100 (QQQ) fell apart.
My thesis has been that the time to be more bullish is when individual stock picking starts to work better. In poor markets most stocks move in tandem as they are driven primarily by the indices. Investors don't care about fundamentals or finding quality stocks when there are huge selloffs. They just want to escape the misery and will sell everything.
Eventually, as emotions cool, the stock pickers will start to look for the best bargains; that is when it is time to become more bullish. The charts won't look very good at the early stages, but there should be some signs of relative strength in place and that is a sign that a bottom is forming.
There are plenty of stocks that have been unfairly sold in recent weeks, but they need better price action before we should risk our precious capital buying them. The risk of another selloff is high, but as support levels develops it will be much easier to handle risk.
Early strength is building as market players start to anticipate better action into the end of the year.
