Why Some Rallies Must Go On Without Us . . .

NOTE:  This Trading alert was originally posted at Ritholtz Research & Analytics on Fri 7/24/2006 7:33 am EDT; An email went out to subscribers alerting them shortly there after.

This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.

One of the issues investors face is the "uncertainty" of the future. Since the future is inherently unknowable, some advisors say, then you might as well just buy the dips and not try to market time.

We look at things from a different perspective. All market environments are not equal. Some offer higher probability set ups for investing; While others are mere coin flips. We prefer when making entries into equities to look for set ups that are better than even money. We like to see either an established uptrend, or conditions that are so deeply oversold as to offer a high probability of success.

At present, neither of those circumstances exist. Markets have been choppy, range-bound, volatile. The "One-day Wonder" last week alleviated much of the oversold conditions that existed. we noted previously that prior to that rally, markets were not nearly as oversold as they were on June 13.  That doesn’t mean they cannot go higher, but it also suggests that the moves will be jerky and unreliable.

Additionally, several technical issues continue to bother us: On Friday, we saw the Dow Transports, breaking their June lows while the Dow Industrials bounced over the June lows. This is rarely a good sign.

Recipes for durable market advances include expanding new highs, expanding overall volume, and advancing volume consistently ahead of declining volume. To quote John Roque, we are getting none of that here.

Thus, we see no technical reasons to rush back into the market at the moment.

This approach means that on occasion, the markets may rally without us. But it also means that over time, we are much less likely to get suckered into false rallies.

Much of the bull case relies on 1) The Fed pausing or stopping; 2) Another double digit earnings period; 3) A quick end to the turmoil in the Middle East.

All three of these beliefs appear somewhat misguided; In the majority of the time, the Fed stopping bodes ill for equities; To many bellwethers have cracked for me to think much of S&P500 earnings going forward;

As to the quick end of the war, consider:  The ground war in Lebanon and Israel just started. I do not see the odds favoring a quick resolution.  I would be surprised if US Secretary of State Condi Rice’s calls for a cease fire are heeded, especially when the US is at the same time speeding up military aid to Tel Aviv. (See this front page Saturday NYT article: U.S. Speeds Up Bomb Delivery for the Israelis)   Its only a guess, but I think the bullish hope for a quick resolution to this war is less likely, and it may go on for a few more weeks at least.  Indeed, the recent pair of bounces in the Tel Aviv Stock Exchange (TASE) may also just be oversold bounces.

~~~

We like to war game scenarios, and we consider this a possible outcome of the recent market action:  The markets have a number of false moves, before making another plunge late July/early August. This creates the deep oversold conditions mentioned above. At that point, we would look for a more advantageous entry.

However, our suspicions at present are that this next oversold move up could be the set up for the final denouement of the markets — a grand shorting opportunity, or for the less trading oriented investor, a move to cash. Despite all the sturm und drang you heard during the May sell off, we still have yet to experience a 10% correction on the Dow or SPX. Of course, the Nasdaq 100 is a total debacle, and I suspoect we could possibly see a revisit of the late 2002 lows on the index.

Note these scenarios are merely educated guesses, one theoretical path out of infinite possibilities. We use them to create mental maps of how markets might progress, and therefore they are subject to swift and merciles srevisions.  We consider them to be "strong opinions, weakly held."

~~~

One final note:   I am looking for feedback on what you want/need/expect from a service like ours. Look for a specific request (not quite a questionaire) later this week.