Thursday, January 17, 2008

Buy or Sell?

In my newsletter you will see an overall 'Market Health' rating for the current month which is either Bullish/Buy or Bearish/Sell. I base this rating on the state of the market internals (Bullish percents, % stocks above key moving averages, and the Summation Index) and the relative position of the markets with respect to support and resistance on yearly charts. The chart below shows my respective calls since January 2006 for each of the months that followed:

It has been a mixed bag with a nice call on 2006 lows, but a missed opportunity on the early 2007 rally. I have remained bullish for December and January as I believe the market is offering discount opportunities for the next rally, particulary in Blue Chip stocks (with Energy perhaps the only sector somewhat overvalued).

Looking back at the Nasdaq over the last 10 years there are some interesting observations to be made:

The longest losing strength for the Nasdaq was a 6 month period in 2002, which led to the absolute low for the current cyclical bull market. The largest % loss came from a 4-month stretch in 2000. During the cyclical bull market there were two periods of 4-month losses in 2005 and 2006, but in each case those losses were recouped.

If markets are entering a cyclical bear phase (which they look like they are) then the probabilty for a complete retracement of the past 3 months declines is reduced, but assuming a Fibonacci retracement there is still good opportunity for long side positions. In situations where the Nasdaq has experienced 3 months of declines, the fourth month has seen a gain on 2 occasions and losses on 4 - so the odds favor a down February. However, January's broad red candlestick looks like a bargain, the question is whether it would be better to wait until February before getting real aggressive, or take advantage now assuming the market will gain some ground back before the month is out.

Dollar-cost-averaging over the next few weeks would make timing such a bottom less of an issue.

But the big question will be knowing when it will become necessary to sell? During the bear market of 2000-2003 monthly bounces were few and far between. If you got longer than a month of gains you were doing well. Selling in May and going away could be the lesson of this year. We'll know more about that when the January 2009 annual review rolls around!