I went back to see what kind of advice I was giving the day before this horrible stretch got started, and was glad to find that I was warning members not to get sucked off the sidelines into rallies, adding: "An intermediate bottom might arrive within 5% to 10% of the current level by the third week of October amid a disheartening and disorienting earning season." As it turned out, the low came in the fourth week of the month, and was 25% lower than the start. Close enough.
Though it seems obvious in retrospect, this was not the consensus opinion then. Advice heavyweight Barrons reported in its last September issue, for example, that conditions in emerging markets "haven’t been this good" in years and recommended that readers buy Brazil, China, South Korea and Russia funds and stocks. Those positions sank 40% to 55% over the next three weeks.
So how about now? Well, stocks are certainly a lot cheaper than they were a year ago, and a month ago. And now that earnings estimates have come down a lot, it looks like we are ready for some upside for a change.
All of the long-term indicators that I study were at their most oversold level in two decades by the middle of last week, and there were some signs of positive divergences as downside momentum was slowing down at new lows. When the S&P 500 hit a new closing low for the year on Oct. 27, the index’s moving average convergence/divergence, or MACD, was actually rising, as was its relative strength index. These are classic signs that sellers were losing their dominance in the short term.
At that point, I recommended the sale of most short positions, and started to turn over to the long side of the market for our trades. I think that the market now has a chance to advance as much as 30% , though it certainly won’t be a straight line.
That would take stocks to their 12-month average, around S&P 1,270, where they have encountered a lot of resistance in the past year. At that point we would have to reassess, but more than likely a new leg of the bear market would then begin, considering we’re heading into a severe recession.
If this occurs, it would be very similar to divergences that appeared during ally efforts in January, March and July of this year. None of those advances lasted longer than a month and a half, though I think this one could last as long as three or four months.
Why not longer?
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The problem is that selling pressure is still strong, and that is a major concern. According to ace volume analyst Paul Desmond over at the institutional research firm Lowrys Reports, studies of the markets over the past seven decades shows that selling pressure peaks well before a market’s final low, showing that major institutions’ desire to sell has been sated.
Examples appear at bear-market lows in 1957, 1970, 1974, 1982, and 2003. Desmond says the span of time between the final peak in selling pressure and the final bear market lows has ranged from one to twelve months, averaging four months.
So even if the October 27 low did represent that start of a multi-month rally, which is possible, it’s still likely to be eclipsed by a lower low later—probably late in the first quarter next year. In the meantime, institutions that did not have an opportunity to sell in February, June or August will take advantage of the latest opportunity to dump positions to a gullible public.
In my Trader’s Advantage letter, we’ll take advantage of this move up by buying stocks and call options, while at the same time keeping our eyes peeled for any signs that the concept won’t work out. My favorite plays now are in civic infrastructure, such as cement, steel and construction equipment.
Come check out the exact names to trade to profit in this environment.
Jon Markman is editor of Trader’s Advantage and a regular contributor to InvestorPlace.com. To get this type of actionable insight from Jon and other InvestorPlace Media experts go to www.InvestorPlace.com today.
