Weekly Market Commentary, March 11th 2008
                 A trading range is a finicky beast. At first glance the boundaries appear reasonable. You know when to buy, when to sell and watch as prices fluctuate in a range. Then, without notice, things change. The predetermined range is gone and we are left guessing about how far prices must move before equilibrium is reestablished.               Currently, we are in the guessing stage. Last week I outlined a trading range between the January panic lows and the interim-high created off that low. The market had spent weeks fluctuating. As we approached new highs, stocks broke down. As we tested the January lows, the market rallied. With a set range, we needed to wait for conclusive action in either direction and then determine the extent of the move. After publishing my view, I did not have to wait long.
               Last week, the markets broke below their January lows. On Monday, the carnage continued. While today’s massive 416 point rally pulls the Dow Jones Industrial Average (DJIA) above 12,100, we are facing a market that has experienced tremendous loss and will continue to do so in the future. With the prior lows pierced, the bears have asserted full control of this market. They have brushed aside all attempts of sustained rallies and ensured that bullish investors experience maximum pain.
               When the DJIA closed on February 27th, it was within 50 points of breaking out to the upside. Over the next eight trading days, the DJIA would lose 954 points (7.5%). From increased pressures in the credit markets to gloomy economic news, the picture darkened enough for the market to experience a semi-crash. While I admit the news is horrible, most of it has been known for months. What truly changed that allowed the markets to reverse so quickly?
               As I have believed for years, true fundamentals will eventually become known. Last summer, risk was widely mispriced. Can we point to one event that caused the markets to reawaken and charge the proper risk premium? I think not. Simply, the market eventually recognized the underlying data and adjusted prices accordingly. Today we are seeing a similar event. While the news of the past week has been incrementally worse than earlier this year, it is not enough to push this market down so quickly. Instead we are seeing the underlying market weakness rise to the surface.
               When we were in the trading range, the bulls made a compelling argument. The market had suffered terrible news, but would not break. Since markets tend to forecast the future, many felt that a market staying above its prior lows was looking toward better days. The combination of increased monetary stimulus from the Federal Reserve (Fed) and fiscal stimulus from Washington would provide enough impact to soften the effect of the credit crunch. I found this argument to be compelling and watched as the DJIA bounced and attempted to move higher.
               Digging deeper, one could see a much different story. In its purest form, a market is an exercise in supply and demand. If supply increases without offsets in demand, prices decline. If demand increases with no increase in supply, prices rise. The easiest way to look at the stock market’s supply/demand balance is through statistics published by Lowry’s. The Lowry’s selling pressure offers an indication of the amount of supply on the market. The buying power numbers indicate the level of demand. What have these numbers been telling us? For the past few months, selling pressure has been increasing while buying power has been falling. In simple terms, the supply of stock for sale has grown while the demand to buy stock has declined. As I learned in my economic classes many years ago, when supply increases and demand drops, price declines follow.
               Along with the dismal supply/demand balance, the market has also faced seven 90% down days since December. Just as ominous, 2 of these occurred over the past four trading sessions. A 90% down day occurs when at least 90% of all stocks are lower on the day and 90% of the total points traded are negative. Simply, 90% down days represent panic action where sellers want out of stocks at any price.
               As the markets were firm during this underlying deterioration, fundamentals eventually won out. The break below the lower end of the trading range confirms that the primary trend of this market is bearish. Within a bear market, we must be very careful. While the natural reaction is to short a bear market, todays powerful rally shows the risk inherent in that strategy. Bear market rallies can be fierce and sudden. Find yourself on the wrong end and wealth will be eliminated in rapid fashion. Instead, we must stick to our core competencies and do what we know best. As with all down markets, this one will eventually pass. When that occurs, no one knows. Instead of trying to call the bottom and execute perfectly timed trades, I will rely upon my research to determine companies whose stock price is trading below the business’s intrinsic value. As opportunity arises, add excellent companies at bargain prices to a well diversified portfolio with above average dividend yield. The market will eventually recognize the value in the gems you have collected and reward you for your patience and discipline.
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I’ve had a few gains & losses this week, but most of my success has been trading around a “core” position. I highly recommend this, initially I thought I could enter in and out of stocks, not the case.
As the volatality (.VIX) (or .VWN for the NASDAQ) has increased, I find myself at odds whether this is a “bear” or “bull” market at current point and time, so following the trend, just have been gaining most of my success on selling the rips and buying the dips.
As far as supply and demand per above, I’m vaguely reminded of the oil inventories reported last week (which were horrible btw), so ….that being said I guess I’m leaning bearish.