The Rude Awakening
Wall Street, New York
Thursday, June 29, 2006 ------------------------- - Ms. Markets delivers a beating – clawing back from
the edge of despair,
- When is the right time to bet on a bear market
reversing?
- All the market data, more than a few sweaty suits on
Wall Street and plenty more...
------------------------- Joel Bowman, from a clamoring, end-of-month Wall Street,
reports... One hasn't had to search too hard to locate a sweaty suit
here on Wall Street over the past few weeks. In addition to
the high humidity of a typical summer in New York City, the
market has been turning up a heat of its own. There have been horror stories aplenty from guys who "just
missed" the timing in this latest market meltdown. "I was
just about to go short," they say, or, "I only just took
off all my hedges..." The operative word in all these
laments, of course, is "just." Now, in a bid to mitigate the month's poor balance sheet,
some traders are furiously looking for ways to claw back a
few basis points. So, what strategy to adopt? Is it time to
start buying back stocks? Or do we have a few more
harrowing plummets to endure first? Jeff Clark of the Short Report has a theory on when and how
bear markets bounce...and it happens to be right below.
Enjoy.
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-------------------------
Bear Market Bounce
By Jeff Clark In a bear market there's no such thing as a long-term hold.
Typical activity in a bear market consists of day after day
of tedious "nickel-and-dime" type declines, followed by
blistering one- or two-day rallies, followed again by a
series of tedious declines. Indeed it seems the purpose of a bear market is to not only
punish the bulls, but also to extract a pound of flesh from
the bears who hang around too long. In order to successfully weather a bear market, investors
have to adopt a trader's mentality. That means shorting
stocks as they run into resistance after the one-day-wonder
rallies – and then diligently taking profits on those short
positions as prices decline into obvious support zones.
Too often I've seen bearish investors, worried that the
market will cascade lower without them on board, put on
maximum bearish bets at precisely the wrong time. Inevitably what happens is that the market puts on one of
those remarkable bear-market rallies and the overexposed
bears end up having to buy back their short positions at a
loss. Keep in mind it was only a few short weeks ago that bulls
firmly controlled the market. We saw higher stock prices
nearly every day for two weeks, and the relentless day-
after-day climb toward new all-time highs caused hesitant
investors to finally capitulate and buy at the worst
possible time. Today, it's the underexposed bears that are feeling
pressure to leverage into position. But that's a mistake.
Just as buying stocks into the relentless rally several
weeks ago proved to be a big mistake, investors who short
stocks into this relentless decline will suffer a similar
fate. There's a rally coming – I can promise you that. It's
simply a question of when. By far, the most successful strategy for trading a bear
market is to wait patiently for the inevitable one-day-
wonder rally that catches all the bears leaning in the
wrong direction. Then, as prices rally strongly up toward
clearly defined resistance lines, establish the appropriate
short positions. I'm not saying that we've officially entered a bear market.
In fact, as you'll see in a moment, the jury is still out
on that issue. But the bull is on borrowed time, and it'll
pay to know the proper way to welcome the bear. The 65-week exponential moving average is widely considered
to be the "line in the sand" separating bull markets from
bear markets. Stocks that trend above the line are in bull markets and
the moving average serves as the last level of support.
Stocks that trend below the line are in bear markets and
the average serves as resistance. Clearly, as you can see from the following chart, the S&P
500 touched a very critical level a few days ago, when it
pierced through the 65-week average at the 1240-level. But
the market bounced back above this level, and even after
yesterday's selloff, sits at 1,242. 
The direction of the market over the next few days will
tell us whether the bull is still running, or whether the
bear is awakening from a three-year hibernation. If the bull market is alive and well, then we should see an
almost immediate move upward. That type of action would be
consistent with the three previous occasions that the S&P
500 sliced into its 65-week moving average. On the other hand, if the bear is now in control, then
stock prices should quickly slice through this support line
and decline perhaps as low as 1175. But even in this case,
stock prices should rebound and come back to "kiss" the
line from below before resuming their decline. Indeed, that
is exactly what happened when the bear market began in
October 2000. For the moment, it looks to me like the low-risk trading
opportunity is to approach the market from the buy side and
to bet on a significant bounce – if only to relieve the
extremely oversold conditions. But I've held that opinion
for most of the past week or two, and all that we've seen
is every single rally attempt get hit with more and more
pervasive selling. Nonetheless, given the excessive pessimism among investors,
the extreme oversold conditions of numerous technical
indicators, and seasonal tendency for a summer rally, it's
a mistake to bet too heavily on the short side just yet.
Remember, bear market rallies are violent and explosive.
Current market conditions are extremely oversold and
susceptible to a strong seasonal bounce. So investors
should be very careful about initiating new short positions
at current levels. The S&P 500 could very easily rally back
up to "kiss" its 50-day moving average at about the 1290
level. That would give us a good low-risk entry point to
reestablish broad market short sales. Until then, however,
it's best to keep our powder dry, except for very specific
low-risk short-sale opportunities. [Joel's Note: For the past twenty years, Jeff Clark has
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