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David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Dave began his investment career in 1980... More
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Daily State of the Markets
  • It's Time To Let Price Be Your Guide 0 comments
    Aug 19, 2013 8:33 AM

    Daily State of the Markets
    Monday, August 19, 2013

    Good Morning. Having spent the vast majority of the weekend in a moving vehicle carting my youngest back to her college in Des Moines, IA, I had plenty of time to "noodle" on the state of the stock market. And with the indices (especially the DJIA) having broken down into what appears to be at least some sort of a downtrend, the key question at this point in time is how low can stocks go?

    As I've mentioned a time or twenty, I don't play the prediction game. However, understanding how corrective phases tend to function can be very helpful in dealing with the way things unfold. Although there is a long list of reasons to be bearish on the outlook for stocks these days, the real key at this stage of the game is to try and determine whether we are dealing with a garden-variety pullback or something more sinister.

    In general terms, a typical pullback in the stock market tends to last a couple weeks and winds up inflicting damage on the indices somewhere in the 3 percent to 5 percent. These types of declines tend to come out of nowhere and take place several times a year. In addition, modest corrections usually end as quickly as they started and the bulls tend to eventually continue on about their business. And frankly, trying to play this type of pullback can be tricky as there just isn't enough room to work unless you are one of the "fast money" types that is in and out of stocks several times each week.

    Then there are what we call "meaningful" corrections, which tend to be much longer and more severe. In short, these are the moves that even those focused on the intermediate-term time frame will want to try to avoid. The duration tends to be longer here with the declines lasting more like a month or two and the damage being something closer to 10 percent.

    The problem however, is that one never knows in advance whether we are going to get a pullback that is brief and manageable or something that makes you wish you had never hit the buy button. And it is for this reason that traders/investors may want to let price be their guide during these types of environments.

    The vast majority of investors attempt to do the opposite and game the expectations for the outcome of the next move. So, now is the time folks. With the S&P 500 off 3.1 percent from its August 2nd high, now is when those folks who like to predict what will happen next will need to make an important decision. Is this move about over? Or is it just getting started?

    Most will look at the issues of the day to help them divine how low stocks can go. As we stated on Friday, there are indeed lots of reasons to be bearish right now including:

    • Current bull market is getting long in tooth
    • Unrest in Egypt/Middle East
    • Political dysfunction in Washington/Upcoming budget battle
    • Slowing earnings growth
    • Worries about 2nd half recovery
    • The "taper" decision
    • Fear of a "policy mistake" by the Fed
    • Rising rates
    • Slowdown in China/Emerging markets
    • The state of Europe (i.e. the banks aren't fixed)
    • The calendar is not the bull's best friend for next two months

    Even the most ardent bulls will need to admit that the above list of "issues" facing the market is a bit daunting. And the bottom line is this may be why the sideways trading range that had been in effect for three weeks or so suddenly morphed into a downtrend last week. As I stated on Friday, if ever there was a self-fulfilling decline, this appears to have been it.

    However, it is important to keep in mind that with the possible exception of rising rates and the growing violence in Egypt, there is nothing new on this list. And remember, in the stock market, something that everyone knows isn't worth knowing!

    So, where does this leave us? Should we assume that the bears are going to remain in control and start adding some shorts via the ProShares Short S&P 500 ETF (NYSE: SH) or the UltraShort S&P 500 SDS's (NYSE: SDS) here? Or is it time to bet that this decline is closer to being over than beginning and to start nibbling at your favorite long positions?

    Since the on-switch to my crystal ball refuses to cooperate these days, and as I said above, this is probably a great time to let price guide your positions. In sum, this is the time to forget about making a big "call" and let Ms. Market simply tell you what she wants to do next.

    What does that mean, you ask? In simple terms, it means that now is a great time to watch the price action. Watch the way the market acts at the 50-day moving average on the S&P 500, which today resides at 1657. Watch the important trend lines, the support zones, your favorite short-term trend indicators, and the Fibonacci retracement levels. And perhaps most importantly, watch how the market acts when the bulls try to make a comeback. Remember, a feeble rebound attempt will likely lead to additional downside while a roaring bounce can often mark the end of a correction phase.

    Finally, recall that bottoms of garden-variety pullbacks are usually "V" shaped and happen quickly. However, more meaningful corrections usually require a "bottoming process" to occur where lows are put in and then tested and retested So again, this may be an excellent time to put away the crystal ball and just let price be your guide for a while.

    Looking for a disciplined approach to managing stock market risk on a daily basis? Check Out My "Daily Decision" System. Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them "in" the stock market during bull markets and on the sidelines (or short) during bear markets.

    Turning to This Morning...

    Things are fairly quiet in the early going on this summer Monday. Vacation season remains in full swing and there is no economic news on the calendar in the U.S. today or tomorrow. As such, traders will be left to their own devices. Currently U.S. futures are following Europe a bit lower and pointing to a slightly lower open.

    Pre-Game Indicators

    Here are the Pre-Market indicators we review each morning before the opening bell...

    Major Foreign Markets:
    - Japan: +0.79%
    - Hong Kong: -0.24%
    - Shanghai: +0.85%
    - London: -0.38%
    - Germany: -0.27%
    - France: -0.72%
    - Italy: -1.72%
    - Spain: -1.14%

    Crude Oil Futures: -$0.40 to $107.06

    Gold: +$4.70 to $1375.20

    Dollar: lower against the yen, euro and pound.

    10-Year Bond Yield: Currently trading at 2.852%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: -4.53
    - Dow Jones Industrial Average: -25
    - NASDAQ Composite: -3.11

    Thought For The Day...

    "The Gods cannot help those who do not seize opportunities." Confucius

    Positions in stocks mentioned: none

    Follow Me on Twitter: @StateDave


    The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

    Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

    The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

    The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

    Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.

    Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

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