One day's reversal does not change a trend

The violent rally on Friday was impressive and as a result of a tight stop changed on Thursday night we covered the short position in NASDAQ futures recommended to Fivestar subscribers. Stocks were extremely washed out and we suspected that any relief from soaring oil prices could lead to a sharp rally in stocks.

So where do we go from here and should we be buying stocks?

Our thoughts are quite clear. Yes, there could be a significant rally and quite possibly one that could deliver a worthwhile short term gain for nimble traders buying stocks. However, the probabilities overall are not favorable for buying stocks generally, and even those stocks that have been bucking the trend may be too risky to buy here.

A feature of recent weeks has been that many stocks bucking the trend have succumbed to selling by those value investors who decided that the price was getting too rich. Then the stock has failed to follow through on the upside and, on the contrary, has set back a good piece, generally far beyond any reasonable stop for new buyers.

You have to remember that bear markets have retracememnts that can go a very long way, as indeed did many downward retracements during the bull market. Our view is that we are now in the early stages of a real bear market. In the early stages of a new bear market there are always buyers willingly to assume that the latest decline has been no more than a correction. We, however, see too many confirmed Ms and downward zigzags on the monthly charts for many, many prominent stocks as well as for indexes such as the SP 500 and the Dow. That is what a bear market is: a succession of lower highs and lower lows.

One of the best tools for estimating how far a retracement might go is the 50 percent rule. You take the most recent high and the most recent low and expect price to rally to the mid-point. For the NASDAQ futures, that level comes in around the 3620 level, or about 10 percent above the Friday close. For the SP 500 December futures, the number comes in around 1450, or about 5 percent above last Friday's close.

In the event that such a rally unfolds, and then stops near the 50 percent level only to turn down again, then you have to consider whether it is worth buying stocks with such a limited expectation of profit. There is always the problem that the stocks you buy may do no better than the averages over such a short time span, although of course they might do better. Then you have to get your entry and exit just right so that in fact you do bank a profit after paying commissions. Frankly, in current market conditions, you have to consider that although your target might be exceeded on the upside, stocks might perversely fall far short of the 50 percent retracement level.

There is a general rule that in a bull market most stocks go up at least to some extent. Therefore, if you don't get the timing just right, time and market forces will see likely you all right. However, you can now look at a chart for a stock like Intel or Cisco and you see that time and the market did not look after you. Sitting tight was a surefire way to lose money. Time and market forces only took care of those who were short these stocks, not those who owned them.

We want to repeat some of the reasons why a resumption of the bull market right now is unlikely, at least not with any vigor.

1. The signs of trouble with profit forecasts are real and serious.

2. Many sectors of the marketplace are becoming saturated, and this includes cell phones and cars, to name two important product areas.

3. Telephone companies and data transmission companies, and many high tech suppliers are faced with a serious case of the law of diminishing returns. Competition is intensifying so that the returns for everyone are shrinking.

4. Everyone in North America who has money is already on the Internet, and so are the majority of people elsewhere in the world.

5. Industrial production in the United States peaked in September last year. Note well, in September 1999. Declining or static production constitutes one of the early signs of a recession.

6. Even after the recent devastation of stock prices, the general level of stock prices is still very high and stocks are very vulnerable to bad news. You might have thought Lucent cheap a couple of weeks ago and then of course it rather rapidly became a quantum amount cheaper again.

When a bear market is coming to an end, stocks stop going down on bad news. It's all already in the market. That certainly is not the case now.

The standard signal we would be looking for to consider buying a few stocks would be to see at least some basing and, ideally a signal such as a double weekly upside reversal or a weekly Lindahl buy signal. As we said before one strong day doesn't cut it. Furthermore, it was actually not such a strong day on Friday. The plurality of advancing stocks over declines was minuscule, with some 10 percent more gainers than losers.

If you find the lure of stocks irresistible and/or if you want to dip a toe in the water at a level that might after all prove good, here is a short list of strictly unofficial recommendations:

Astropower (APWR)
Cerner Corp ( CERN)
Ciena (CIEN)
Linear Technology (LLTC)
Idec Pharmaceuticals (IDPH)
Emulex (EMLX)
Genzyme (GENZ)

We could, naturally, be wrong in our interpretation of the prospect for stocks. However, we have no hesitation in taking the position that that's not the point. We can state quite categorically that, right or wrong, we don't like the risk of buying stocks here.

Having said that, there is just one sector in which we have long-term confidence and that's the oils. Our recommendations have been holding their own, which is a poor performance given what oil prices have been doing. Nevertheless, we expect these investments to pay off royally in due course. In the meantime, we strongly recommend using major rallies to sell stocks, particularly ones that have been performing poorly. The proceeds should be held in Treasury Bills and the money market.

Stockscom