Preparing for a Rally

Since the Dow Jones Industrial Average (Dow) peaked in October 2007, we have witnessed relentless wealth destruction. House prices have been falling for over a year, worldwide stock markets are down nearly 50% and commodity markets have been bludgeoned over the past 2 months.

Except for investors piling into Treasury securities at non-existent yields, everyone has been hurt. The market has been oversold for nearly 2 months, yet no rally arrives. Investment luminaries speak of the incredible values to be found, yet no rally arrives. The Federal Reserve (Fed) has unleashed nearly $8 trillion of new lending programs, yet no rally arrives. At this point, will a rally ever occur?

Last week, signs indicated that the oversold bounce was occurring. After hitting an intraday panic low and reversing, the Dow moved nearly 19% in five days. To start this week - a 7.7% drop. As the market has attempted to respond to this drop, we must still ask the question - will a rally ever occur?

It will and it has. One of the more important aspects to track in the market is how stocks respond to news. As we all know, the economic environment is poor and deteriorating. As I outlined in my weekly newsletter, here, the employment picture is set to worsen over the coming months. With that, we should see a drop in consumer spending, asset values and more business closures. When negative news enters the market, the natural path is for stock prices to fall. When markets cease falling on bad news, a temporary bottom has been established.

Yesterday's announcement of Research in Motion's (RIMM) performance has me believing the next major move is higher. Tuesday, after the market closed, RIMM preannounced earnings and revenues that missed analyst forecasts. The miss was quickly followed by analyst downgrades as concerns mount over RIMM's ability to sell their product in the current economic environment.

When I turned on my trading system yesterday morning, I saw the shares trading near $32 and expected the worst. However, the shares opened at $35.40, strengthened during the day and closed near $39 - a gain of $1.64 on the day and nearly $7 (22%) above the premarket level. When a company with poor earnings and negative analyst comments stages such a move I pay attention. A market that rallies on bad news is destined to move higher. After all, if bad news resulted in such a move, how high would the price go if we received positive information?

Over the next 6 weeks, I expect an uneven march higher. Given the large decline in the Dow, we could easily move toward 9,600 and remain in a well-defined bear market. Such a move would offer nearly an 11% upside from yesterday's close and would represent a 27% move from the panic lows that occurred on November 21st.

While this move is expected and welcome, I caution investors to not become complacent or greedy. I firmly believe we will experience difficult economic conditions for the next 9-12 months that will dwarf what most people have experienced in their lifetime.

Personally, I see unemployment reaching 10% as nearly 4 million Americans lose their jobs. Our economy and banking system were not built for this level of unemployment and the downstream effects will be painful and difficult. For this reason, I urge investors to use any coming rally to realize gains, rebalance their risk profile and prepare for the road ahead.

Eventually the market will hit bottom and have only one direction in which to travel - up. However, that point remains in the future and rallies are to be sold in order to prepare for lower prices that lie ahead.

Comments

[digitaldorobo:]

"Personally, I see unemployment reaching 10% as nearly 4 million Americans lose their jobs"

Add 5%. Just like the CPI, unemployment has been much higher than the government stats actually admit. Check out www.shadowstats.com/

Politically, it is not in the government's interest to show bad economic statistics. When gas and food gets factored back into the CPI, I'll start believing what the government publishes.

2008 Dec 04 08:50 AM

[elwind45:]

Churning the rest of year for commissions. Sell toward end of month and bank profits which will be off-set by losses. Traders?

2008 Dec 05 04:44 AM