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Minyan Mailbag: Time To Buy?


Short-term risk reward in favor of a bounce.


Prof. Smita,

The markets tumbled across the globe after the bailout bill failed in Congress. Is it time to remain cautious or is this a good buying opportunity?

-Minyan Veronica


When I voiced my fears on 9/11, S&P 500 was at 1249. Yesterday in a stunning collapse, it closed down almost 11.4% to 1106. Given that there are many indicators that went to oversold levels in this stunning two-week decline, my opinion is that we have enough fuel for at least a short term bounce. Here are some of those indicators.

  • VIX is capturing the fear in the air. On 9/29, it spiked 34% to 47.

    S&P-500 is very close to the 61.2% Fibonacci retracement level of the rally from 2002 lows to 2007 highs. Here's the key retracement levels
    38.2 % 1,267
    50.0% 1,172
    61.8% 1,077

  • Percentage of stocks under 10 day moving average close to 5 showing that the market is very oversold, in the short term.

  • There is a lot of cash on the sidelines, which can fuel a bounce once it starts. Rydex Money market assets as percentage of total index assets were at a significantly high 43% last week.(Source

There are certain things to keep in mind though. First of all, let's study the technical anatomy of market-bottoms by analyzing the lows in the 2000-2003 bear market.

Click to enlarge

Notice in the above chart, there were many visible lows, but none of them stuck as "the ultimate low," even though they were followed by massive bear market rallies.

Click to enlarge

As the above chart shows, it took several attempts by the market to test and possibly retest, while the underlying conditions improve steadily. We saw July 2002 levels being tested in Oct 2002 and then again, a higher low was made in March 2003. But unlike the previous chart, the market stopped making new lows and successfully defended the low hit in July 2002. What made the March 2003 level test significant was the positive divergence in many underlying indicators. And in the current environment, there's no positive divergence in place as of yet.

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The last bear market low was ushered in, after SP-500 decline of 47% from 2000 highs and even after that decline, it took about 8 months for the market to stabilize and move higher. For reference, S&P had lost 29% from Oct 2007 highs to Sept 29th, 2008. So, with the knowledge that bottoming formations take time, I would not establish any long term investments here. I am not looking for longer-term lows yet; only short term long-trades.

The second consideration is whether to invest in blue chip stocks in the hope that they are good values. After all, Google (GOOG) and Apple (AAPL) are down 48%, Research in Motion (RIMM) has declined 58%, even the hot Potash (POT) has fallen 45% while SP-500 is down merely 29%. Surely the selling seems overdone in individual names?

Well, the 2003-2007 bull market could not take the popular blue-chips like Cisco Systems (CSCO), International Business Machines (IBM), Microsoft (MSFT) and General Electric (GE) to their old glory days, while most major indexes did revisit their 2000 highs. Instead, new-age tech stocks like AAPL, GOOG, RIMM, and commodity and metal plays such as United States Oil (USO), Schlumberger Limited (SLB), SPDR Gold Shares (GLD), United States Steel (X), Arcelor Mittal (MT), Potash (POT) were the new 'blue chips' during this time! So, I would advocate diversified positions in index ETF's such as DIAMONDS Trust, Series 1DIAMONDS Trust ( DIA), iShares Russell 2000 Index (IWM), SPDRs (SPY), Ultra QQQ ProShares (QLD) till the dust settles and we have determined leadership.

Thirdly, as the above chart showed, there is massive volatility and churning during this period. Such periods in time prove difficult for trading and can significantly harm the portfolio. Given that, I would reiterate a cautiously long stance, in market ETF's, rather than individual new stock positions.

The short-term risk reward has finally turned in favor of a bounce. If it turns out to be the bear market bottom remains to be seen, it certainly does seem like a tradable bounce.

Good trading!

-Prof. Sadana

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