Minyan Mailbag: How Vicious Will Bear Be on Its Last Legs?

Remember that 300 point rally on Fannie/Freddie day, where did it go? Well, like so many rallies since the credit bubble burst, it was merely short covering. The shorts simply covered and now they are waiting too see if new money enters the market. Unless that happens, better look out below. But the only new money I see coming into this market is plunger money. With the VIX at 24 below could be a long way down.

Professor Sadana,

Now that the retest you've been talking about is finally here, do you think it will be successful? Can the market go higher now?

Thanks,
Minyan Tim


Minyan Tim,

I fear that unless we see a massive rally on high volume and positive breadth, the July lows might be in danger of getting taken out.

For a retest to be deemed successful, the market should've come down on low volume with healthier marker internals. Instead, the volume on recent decline has been heavy, some internals are worse, and the leaders are weak. The selling has permeated many sectors: Some like the Semiconductor Index (SMH) have hit new multi-year lows. One of the strongest indexes of the last rally, the NDX-100, has decisively breached the July lows based on weakness in stocks like Apple, Research in Motion and Google.

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Certainly, there are some signs of light in this darkness, such as the strength in the DOW Transports, and the percentage of stocks above their 40 day moving averages, but these signs are few and far between.

My worry is that this weak market rally, sprouting from seriously oversold conditions persisting for a historically long time, is going to give way to heavy selling. I have been particularly concerned about the inability of the S&P 500 to capture its 200-day moving average.

If such seriously oversold conditions couldn't attract buyers, it’s obvious that the prices need to be lower in order for sustained-buying interest. The market has continued to act like soggy firewood, unable to ignite buying, even at the Fannie Mae and Freddie Mac news.

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The irony is this: Even though the S&P is close in price to its July lows today, at 1231, it lacks the oversold conditions faced at that time. Certainly, there are some signs of fear in many individual stocks like First Solar (FSLR), US Steel (X), Baidu (BIDU), Potash (POT), Caterpillar (CAT), Arcelor Mittal (MT) and Foster Wheeler (FWLT), but the market on the whole is still holding its own.

Once the fear moves over to the indexes and translates to attractive prices for the buyers, we can usher in a tradable bottom.

Investors and traders should continue to tread in this market cautiously, with small positions (if any) in quality stocks, tight stop-losses and a large portion of the account earmarked for cash. The tail end of the bear can be very vicious, so capital preservation should take prime importance.

Of course, my views would change if I saw an encouraging transformation in the market's character. I would need to see across-the-board buying on excellent volume, and the S&P regaining the 1305 level on 10:1 positive breadth in order to feel better about the market.

Till then, the abyss beckons…

Sincerely,
Professor Smita Sadana