Wednesday, February 18, 2009

Stock market still in a trading range, but moment of truth coming up

The stock market has been bouncing up and down within a broad trading range since the November low, "trading sideways" as they say. So far, none of the big three averages (Dow Industrials, S&P 500, NASDAQ Composite) has set a new low since November, almost exactly three months ago. Usually in a bear market you see new lows set at a greater frequency. Now, as the market approaches the November low, one of two things will happen: 1) the market will fall below the November low, setting a new low, and signaling to traders and speculators that the bear market continues and inspiring them to place further bets (i.e., to open more short positions), further pushing the market down, or 2) traders and speculators will soon reach the point of "selling exhaustion", they will begin to "take profits" by closing out short positions (essentially buying stock), causing the market to rally, signaling a "double bottom", which is a bullish signal, and kicking off a big rally to continue the next phase of the trading range (and maybe eventually a bull-market breakout, maybe.)

The grand question is whether the market is about to anticipate the success or failure of the government's stimulus efforts, whether the market believes that business will stabilize and begin to bounce back six to nine months from now.

Sure, traders and short-term speculators panned the revised bank bailout plan last week, but the recent market declines have been within the realm of this three-month trading range and "range traders" can only push the market so far before they run out of ammunition and patience and start closing out their positions ("taking money off te table") and placing their new bets as the market evolves. They managed to do a great job of talking down the new Treasury plan, ignoring the passage of the stimulus package, ignoring the GM recovery plan, and ignoring the upcoming foreclosure package. But very soon, within the next few days, we will see if their short-term, knee-jerk reaction was just a short-term range-trading strategy, targeting a "re-test" of the November low, or whether the underlying market is actually deteriorating faster than the recovery from the November low suggested.

It is very possible that we could see a minor bounce soon, but that could mask a so-called head-fake, inspiring short-term traders to abandon some of their short posititions, but quickly resulting in them re-opening those short positions when they realize that the bounce was a head-fake and inspiring a market decline to finally get to the actual "re-test" of the November low.

Note that all of this is about short-term trading and speculation and has nothing to do with true investing.

One other thing... so far, the market action looks a lot like the run-up to the Iraq War, where a low was hit in October of 2002 and a significant rally occurred, but then the market traded sideways and down until it tested the October low in March of 2003 and then kicked off the next leg of a bull market recovery. We could be seeing such a setup right now.

In any case, the market is ultimately "the sum of all curves", the sum of all individual bets being placed. Do you believe that Obama, Geithner, Bernanke, and Summers are all idiots and really stupid? Or, do you believe that they are in fact up to the challenge before them? But also keep in mind Keynes advice that the market can remain irrational far longer than you can remain solvent.

-- Jack Krupansky


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