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Is the Worst Over for the Market?

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It's natural to hope for some relief after slogging through a period of ugliness like we've seen recently.

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MINYANVILLE ORIGINAL In my last missive, I mentioned that both the Dow (INDEXDJX:.DJI) and the S&P 500 (INDEXSP:.INX) were doing a good job of holding above key support levels despite some real damage under the surface in some big cyclical names. However, I also said that the Nasdaq (INDEXNASDAQ:.IXIC) had already entered a confirmed intermediate downtrend, and at some point, that divergence would resolve itself.

Unfortunately, that resolution was to the bulls' detriment. On Tuesday, not only did the senior indices push emphatically below their respective 50-day moving averages, but they also put in lower lows, and fell back below their big multi-year breakout levels from back in early September.

There's no big mystery about what's going on here. Expectations were quite low coming into earnings season, but the revenue misses and downward guidance has just been too much. I know that it's kind of weird to see stocks reacting to actual news instead of rumors, but there you have it.

The action Tuesday left us with some short-term oversold readings, and this morning, we've got a bit of a bounce brewing. The question, of course, is if the market has effectively priced in the news and if we can start picking up some names that might be on sale. It's natural to hope for some quick relief after slogging through a period of ugliness like we've seen recently, and when we do finally bounce, it's easy to start thinking that the worst is finally over. Given the tendency for this market to put in V-shaped bounces, it's dangerous to dismiss the chances for a quick recovery, but it's far more important to respect the pattern of lower highs and lower lows.

That's not to say, though, that there won't be some good trading opportunities in the context of a downtrend. I've got my eye on a few small names like IMPAC Mortgage Holdings (NYSEAMEX:IMH), Eloqua (NASDAQ:ELOQ) and Reed's (NASDAQ:REED), but the key is to make sure that you're keeping a tight rein on any trades and are shortening up your time-frames. I'll leave the grand predicting to others. Give me some real signs of stabilization and show me some persistent dip buying, and then I'll worry about building more substantial positions.

At the same time, I continue to think that there will be some good trading opportunities into the end of the year. I'm a big fan of historical studies, and I regularly follow Wayne Whaley, a well-known newsletter author who takes an engineering approach to stock analysis. Yesterday, he sent out an update highlighting the fact that there is a strong tendency for decent gains in the fourth quarter when the S&P 500 is up at least 10% for the year and had a positive September. Under that scenario, however, October has a record of 6-8 with a median loss of 1%, while November and December are both 10-4 with median gains of 3.2% and 1.7%, respectively. Add to that the fact that election years also tend to be positive, and there's good reason to be ready to move should the action improve.

So, as the saying goes, be nimble. I'm hopeful that the bulls will regain their footing, but we're going to need to see some broken down leaders stabilize and start perking back up before we can think that the worst is over.

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No positions in stocks mentioned.
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