Before You Jump on the Bullish Alcoa Bandwagon …

by James Brumley | April 11, 2012 8:25 am

Before You Jump on the Bullish Alcoa Bandwagon …

What a mess. And amazingly, it only took a few days to create it.

Five days, to be exact. That’s the number of consecutive daily losses[1] the market had suffered as of Tuesday. It’s the worst losing streak since November, not to mention a seed of doubt as to the market’s near-term future.

On the other hand, Alcoa’s (NYSE:AA[2]) earnings beat — a surprise profit of 9 cents per share — might well act as a market-wide recovery catalyst today. It couldn’t have come at a better time, either … right when the market felt more than a little oversold thanks to Tuesday’s 1.2% drubbing, which inflated the total size of the pullback to 4.3% so far.

So which is it? Are we destined for even more downside, or will the strong start to Q1’s earnings season abruptly turn things around? Actually, the situation isn’t nearly that simple.

One Way or Another

The media is great at finding reasons for rallies and pullbacks. That’s not to say the media is right about those reasons — they’re just great at linking causes and effects.

Take the current selloff as an example. A combination of weak job growth, renewed fears over Europe’s debt (Spanish bonds are in the spotlight this time), swelling inflation in China and expectations of tepid earnings growth last quarter have all been deemed culprits for the retreat.

There’s another possibility, though. It’s not one the media likes, because it doesn’t fit into a neat and tidy commentary. Veteran traders, however, will be more apt to believe it than any of the other posed reasons for the pullback.

After a 17% run-up over the span of four months, it was just time to lock in some profits.

No, it’s not sexy. Given that none of the other named culprits are actually new or surprises, though, the “time for a reversal” theory is just as valid as any of the others.

Whether you agree isn’t even the important part of the issue at this point. The question now is: Where do we go from here?

The Fat Lady Hasn’t Sung Yet

Never say never, but assuming the correction that started last week is a normal one, we ain’t hit bottom yet.

sp500 300x208 Before You Jump on the Bullish Alcoa Bandwagon ...
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No two pullbacks are ever the same. But, there is a typical size of a bull market correction. The average dip is right around 9%, with most of them ranging from 7% to 11%. Those aren’t numbers to get married to, but they’re a great place to start putting things into perspective.

And interestingly (though not surprisingly), there’s a great deal of technical support at levels about 9% below last week’s multi-year highs.

For the S&P 500, a 9% dip from the recent peak of 1,422.38 would put the index at 1,294.4. The 7%-to-11% range for a normal pullback would span from 1,322.8 to 1,265.9 for the S&P 500. That’s right in line with Fibonacci retracements of 38.2% and 50%, and very near where the important 100-day and 200-day moving average liness would be by the time they could be retested.

In other words, there’s a lot of organic support right where organic support usually is found. Conversely, there’s little to no technical support anywhere near where the S&P 500 closed Tuesday.

But What About Alcoa’s Good News?

Ahh, yes … Alcoa, the harbinger of earnings season’s bullishness or bearishness.

Here’s a little secret about Alcoa acting as a barometer for the entire earning season’s success: It’s crap.

Truth be told, at one point in time there likely was to be something to it. The company processes and sells aluminum, and since aluminum demand generally was a sign of economic growth, if Alcoa did well, other corporations must surely have enjoyed the same economic growth.

But now, commodity prices are a cat-and-mouse game driven as much by interest rates as by demand. And there are so many alternatives to Alcoa, its revenue and pricing power might or might not be a reasonable measure of broad economic health. The market and the media still like to connect those dots, though, since — as was noted already — the idea is a neat and tidy one that makes superficial sense when put into a commentary. Just don’t bet the farm on the premise.

That’s an important reality to keep in your back pocket not just today, but for the remainder of earnings season.

As it stands right now, Alcoa shares are poised to bounce, and it looks like the broad market is poised to rally today as well. Don’t assume that’s just because Alcoa topped estimates, though. It’s largely because both Alcoa shares as well as the overall market have gotten the daylights beat out of them over the past several days, and anything will bounce if dropped from high enough.

Let’s see how the bulls are feeling by Friday.

Bottom Line

Instead of drawing conclusions from one day’s action, we really need to take a step back and look the bigger picture here. Stocks took on more water over the past five days than they have at any point since November. The difference this time is, traders have some fat gains to defend.

The sellers might take a break in the latter half of this week, but they’ve already tipped their pessimistic hand … and we already know the pullback so far is well shy of the norm.

Just keep it all in perspective.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. number of consecutive daily losses: http://investorplace.com/2012/04/dow-takes-drubbing-tuesdays-ip-market-recap/
  2. AA: http://studio-5.financialcontent.com/investplace/quote?Symbol=AA

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