The job of a good bounce in a broken market is to convince you that the worst is over. The market wants your precious capital to stay invested in stocks -- and it will do its best to assure you that the pain of a correction is over and the future is bright.
We are at that stage in the current market right now. There has been a sizable bounce off the December 24 low, and despite some good moves, the focus of many market players isn't on escaping this market that treated them so poorly in the fourth quarter, but on not missing out as the recovery continues.
It is easy to justify a more-optimistic viewpoint at this juncture. The Fed is now sounding much more dovish, there is progress on the trade issue with China, quite a few economists assure us there is no sign of a recession and earnings season is about to start. Even the longest governmental shutdown in history isn't causing much concern.
Historically, a market that is acting this way tends not to go straight back up. Usually there is a significant pullback and a very high likelihood that the lows are eventually tested. Yesterday, I posted a study that shows that a typical bounce after an oversold bounce is around 11%-12% Currently the S&P 500 is up about 10.9% from the low hit on December 26.
Of course, it is the job of the market to make it difficult. The market beast wants us to believe that this time it is different -- and that maybe this time the market is going to keep going straight up with barely a pause along the way. The goal is to cause as much pain as possible for those that are inclined to trust the strength.
I often discuss how I focus on reacting to the market as it develops, rather than try to anticipate the twists and turns. I want to embrace the price action that is in front of me and not fight it. However, that doesn't mean that I don't have a thesis as to what may occur. Having a thesis aids me in reacting quickly as a change occurs.
I always try to stay open-minded and objective about the market, but my view has been more negative recently, as I find it increasingly difficult to find stocks that I want to buy. While the price action is obviously better, the entry points are difficult. I am not inclined to buy a stock that has gone up 10 days in a row and is hitting resistance. While it may continue to go higher, it just isn't prudent to chase momentum this late into a bounce.
My game plan is to keep on looking for stocks to buy, but to stay disciplined about entry points. In addition, I am watching very closely for signs that a pullback of some magnitude is developing in the indices. I don't want to try to front run a rollover, rather I want to be mentally prepared to add quickly to some index shorts when there is some weakness. A lower higher and a weak close will be the tipoff that maybe a change in market character is beginning.
One interesting aspect to the action right now is that earnings season is starting and the reaction to reports is likely to be the main catalyst for the new move in the market. Yesterday, we saw a bounce in Citi (C) following its so-so report, which suggests that expectations for reports are low. However, there is the danger that more warnings are lurking like the one we had from Apple (AAPL) .
We have a positive open on the way as China continues to find ways to stimulate its economy, but a Brexit vote is coming up and may produce some movement.