Is the Market Rally for Real?

Whether we are seeing the beginning of a new bull market or just another bear market rally, the two month upswing has been quite extraordinary. As can be expected, the perma-bears and perma-bulls are out in full force, arguing their case with the vigor of someone that has a direct line to Nostradamus. Where do I stand? While the recent move upward has been encouraging, I have not joined the longs. Why?

Unless one is willing to cut losses quickly, playing rallies during a confirmed bear market can be a dangerous game. Sure, this rally has been more than a three day wonder, and if you played your cards correctly, you are sitting on a pile of money. Congratulations, do not begrudge your success. However, if you played the last several bear market rallies and did not move to sell quickly enough, you could end up in what one of my former non-commissioned officers referred to as, the “hurt locker.” For every rally that sticks, there are three or four that do not.

If we are indeed on the verge of a multi-year bull market, there will be plenty of time to go long and make money. Heck, when the time comes for the market to surge forward, one can almost throw darts at a stock table and pick winners. But for position traders, buying at the March low was not a prudent time to go long; jumping in now after an extended run is even more dangerous to your wallet. The market needs to prove itself - and it has yet to make the case.

One warning flag has been the lack of leadership in this rally. No one group has bolted out of the gate to lead the way. While a lot of stocks are now sitting on sizeable gains, one needs to consider the oversold levels that needed to be worked off. Moreover, as is usually the case, the previous leaders will likely not be the leadership in the next bull market.

Clearly, the market is extended and in need of a break. The percentage of stocks over their 50 day moving average has exceeded over 80 percent - an overbought level - since the beginning of April. Granted, the market can stay at that oversold level for some time, but to venture into an extended market now is a recipe for disaster.

Further confirmation of an impending pullback is the fact that the Nasdaq has reached its 200 day moving average (DMA). The S&P 500 and DJIA are also not far off of testing their respective 200 DMAs. Looking back at the bottom of 2002-2003, we can see that when retesting this moving average, the Nasdaq just did not barrel through and continue upward. It took several times before it could breach the 200 DMA. Expecting the indexes to move through this area after such huge gains is asking for a lot.

So, what is a position trader to do? Relax! Let the market show its cards. How the indexes react after a pullback will be the critical test. If they can come back and break out above their recent highs, and leadership emerges, it might finally be the time to go long stocks.

Comments

[capt Brian:]

Great strategy. Prudence is usually rewarded. I for one concur with the author. In fact I have a teeny short position in FAZ and a nice spot in PM's physical, and NO other stock at this time.

I think the rolly coaster is at the top and is gonna begin any day now, an interesting plunge to new lows. Just after the new lows, when everyone cleans off thier dinner, I have no idea, Not looking for a recovery for a while

Capt Brian

May 10 08:55 AM

[HChang:]

We are half way through a W, at the peak in the middle of that alphabet. So sit tight, ti's going down soon.

May 10 10:03 AM

[Alphameister:]

I don't expect to see new lows, and I expect the market to end the year above current levels, but the future is always uncertain and I agree it is a time to become more defensive for a wide range of reasons ranging from heavy insider selling to those 200-day averages cited above.

May 10 10:17 AM

[Prudent Man...:]

Is there a Santa Claus?

Watch interest rates. If the prime goes back to it's average 6.00% how many business will be able to cover their debt service. I doubt many can cover 4.00%.

I don't like the percentages in the cards being dealt. It appears to me that too many are putting their money on a wish rather than fact. If they are right I will enjoy the show. If not, greed has its costs.

Institutional investors are the "odd lot" traders of the fifties and sixties. Considering that many have to be in stocks is a loser's game in itself.

May 10 01:42 PM

[Mad Hedge F...:]

The rally is real, but so is the risk. Let’s say we spend our $2 trillion and get a couple of quarters of weak 2% type growth. Then once the effects of the stimulus wear off, we slip back into recession, setting up a classic “W” type recession. Unemployment never does stop climbing. This happened to Roosevelt in the thirties. So congress passes another $2 trillion reflationary budget. Everybody get’s wonderful new mass transit and alternative energy infrastructure. But with $4 trillion in spending packed into two years inflation really takes off. The bond market collapses, the dollar tanks big time, gold goes ballistic to $3,000, and silver to $50. Ben Bernanke’s replacement has no choice but to engineer an interest rate spike, taking the Fed funds rate up to a Volkeresque 20%. Housing, having never recovered, drops by half again. This all happens in the 2012 election year. Obama is burned in effigy, a Mormon is elected president, and the Republicans, reinvigorated by new leadership, retake both houses of congress. We invade Iran. Crude hits $200. This is not exactly a low probability scenario. Remember Jimmy Carter? This is why junk bond yields are still stubbornly high at 14.5%, and credit default swaps are at lofty levels. The risk of Armageddon is still out there. Just thought you’d like to know. Pass the Ambien.

May 10 11:07 PM