Of Trends, Traditions, And Commandments

I know that I have mentioned this before, but I believe one of my favourite Wall Street-isms nicely sums up the current stock market environment.

Long-time readers will undoubtedly recognise this oldie-but-a-goodie, so feel free to join in now… On Wall Street, if something happens once, it is considered a trend. If it happens twice, it is a tradition.

And if it happens three times, well, it’s a commandment.

So, with the stock market moving higher for a second day in a row on Friday, short-term traders are likely to believe that the trend is now up.

Well, except for the fact that the definition of short-term in the HFT age is the next 30-seconds, while long-term is lunch.

But for the rest of us, the short-term trend does appear to be improving a bit relative to this time last week. In all seriousness, the key question at this point is if the bottom has been put in and if a new uptrend has been established. To be honest, I’m not sure on either count.

But the four consecutive successful tests of the 1120 level suggests that this area should be considered pretty decent short-term support. So, the bulls have that going for them, which, to borrow a line from Caddyshack, is nice.

The bulls can also point to any number of studies that prove within a shadow of a doubt that buying after such intense declines is almost always a successful trade. In fact, I can add a new study to this list.

According to Ned Davis Research, when the percentage of stocks in their Multi-Cap universe which are above their 200-day moving averages drops below 14%, stocks are higher, on average, one week, two weeks, one month, three months and six months later.

And given that the most recent signal occurred on August 9th, those that love these historical references can be heard joyously exclaiming “Buy ’em!!” Since 1981, there have been 10 previous signals given. Thus, it is clear that such an event doesn’t happen very often.

On average, the S&P 500 was higher by +3.4%, two weeks after the signal, +3.07%, one month after the signal, +4.8%, three months later, and +6.14% six months later. It is also worth noting that, with the exception of the 6-month returns, the gains put up by the S&P 500 after the signal were all multiples higher than the historical average for the market.

However, there is at least one gaping problem to consider before you start buying the UPRO’s on margin. First, this signal has proved to be WRONG 30% of the time one week out, 20% of the time two weeks later, and 30% of the time one, three, and six months after the signal was given. In addition, the last two signals given actually produced significant losses for all five time periods! In response to which, I’ll refer back to the title of this morning’s missive.

I believe the key takeaway here is something that is being missed by most of the talking heads these days. You see, IF a market bottom is put in during a waterfall decline, it is clear that stocks have tended to rebound impressively for obvious reasons (the crisis ended with the waterfall). However, it is worth noting that most waterfall declines in the past have been associated with what are called bad-news panics such as the Crash of ’87, the first Gulf War in 1990, and the LTCM/Russian debt default of 1998. It is also important to understand that these all occurred during secular BULL markets – when corrections tend to be short and swift. In studying the data further, I find that since 2000 (when the secular BEAR began), there have been 5 previous waterfall declines that took the percentage of stocks above their 200-day moving averages under 14%. One week later, stocks were lower 3 out of 5 times; the last two times the signal occurred, and stocks fell by an average of -1.74%.

Two weeks later, stocks were lower two out of five times, the last two times, and by -0.48% on average. One month later, the market was lower 2/5 times, the last two times, and was higher by 1.89% on average, which is actually above the average for all one month periods.

Three months later, stocks were down three out of five times, the last two times, and were up an average of +0.21% (which is lower than the average gain of +2.21% for all three month periods). And finally, six months later, stocks were lower three out of five times, the last three in a row, and were off by an average of -1.47% over the 6-month period.

Thus, in looking at the data since 2000, it is pretty darned obvious that buying on this type of stocks-have-gone-down-a-lot-in-a-short-period-of-time-so-it’s-time-to-buy signal isn’t necessarily the panacea being touted by so many. In fact, there are even a fair amount of trends, traditions, and commandments in the results!

My point is that despite the trends, the traditions, or even the commandments available, it is likely best to recognise that this market remains dangerous due to the fact that the economic fundamentals continue to be a very big question mark. Sure, stocks can continue to bounce if nothing bad hits the wires over the next few days.

But another question to ask yourself is how much higher can stocks go given the economic environment? But then again, if we start to see a trend or even a tradition or two of stronger data… Turning to this morning… Japan’s GDP report came in with a smaller decline than analysts had projected which triggered buying in Asia.

And while it is a holiday across continental Europe, most markets are trading higher in response to narrowing yield spreads. And finally, in deal news, Google is buying Motorola Mobility (MMI) for $12.5 billion, which represents a 63% premium to MMI’s closing price from Friday.

On the Economic front… The Empire Manufacturing Index (designed to indicate the state of the manufacturing sector in the New York region) for August was reported at -7.72, which was below the consensus expectations for a reading of -0.1. We will also get a report on the NAHB Housing Market Index at 10:00 am eastern. Thought for the day… Will you make time for you today?

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

  • Major Foreign Markets: Australia: +2.57% Shanghai: +1.30% Hong Kong: +3.26% Japan: +0.20% France: +0.20% Germany: +0.84% Italy: Closed Spain: -0.22% London: +0.47%
  • Australia: +2.57%
  • Shanghai: +1.30%
  • Hong Kong: +3.26%
  • Japan: +0.20%
  • France: +0.20%
  • Germany: +0.84%
  • Italy: Closed
  • Spain: -0.22%
  • London: +0.47%
  • Crude Oil Futures: +$0.28 to $85.66
  • Gold: -$5.70 to $1736.90
  • Dollar: higher against the Yen, lower vs. Euro and Pound
  • 10-Year Bond Yield: Currently trading at 2.262%
  • Stocks Futures Ahead of Open in U.S. (relative to fair value): S&P 500: +6.14 Dow Jones Industrial Average: +57 NASDAQ Composite: +2.50
  • S&P 500: +6.14
  • Dow Jones Industrial Average: +57
  • NASDAQ Composite: +2.50

Wall Street Research Summary

Upgrades:

  • Waters (WAT) – Auriga
  • Bemis (BMS) – BofA/Merrill
  • Meadwestvaco (MWV) – BofA/Merrill
  • Sealed Air (SEE) – BofA/Merrill
  • WW Grainger (GWW) – BofA/Merrill
  • Tyco (TYC) – BofA/Merrill
  • Limited Brands (LTD) – Barclays
  • Ralcorp Holdings (RAL) – BB&T
  • Express Scripts (ESRX) – BB&T
  • Tyson Foods (TSN) – BMO Capital
  • Bed Bath & Beyond (BBBY) – Cowen
  • VMware (VMW) – Credit Suisse
  • Visa (V) – Added to Conviction Buy at Goldman
  • cognisant Technoloty (CTSH) – Added to Conviction Buy at Goldman
  • F5 Networks (FFIV) – Goldman Sachs
  • IBM (IBM) – Goldman Sachs
  • Family Dollar (FDO) – Goldman Sachs
  • Sara Lee (SLE) – Target increased at Goldman Sachs
  • Ecolab (ECL) – Jefferies
  • Las Vegas Sands (LVS) – Mentioned positive at JPMorgan
  • Sunoco (SUN) – Macquarie Research
  • Hot Topic (HOTT) – Piper Jaffray
  • NetApp (NTAP – Piper Jaffray
  • Cathay Bancorp (CATY) – RBC Capital
  • Zions Bancorp (ZION) – RBC Capital
  • Dell (DELL) – Target and estimates upped at UBS
  • Oasis petroleum (OAS) – UBS

Downgrades:

  • AptarGroup (ATR) – BofA/Merrill
  • Plum Creek (PCL) – BofA/Merrill
  • Illinois Tool (ITW) – BofA/Merrill
  • Colfax Corp (CFX) – BofA/Merrill
  • PetSmart (PETM) – Barclays
  • Pier 1 Imports (PIR) – Barclays
  • Williams-Sonoma (WSM) – Barclays
  • Sanderson Farms (SAFM) – BMO Capital
  • Juniper Networks (JNPR) – Goldman Sachs
  • Brocade (BRCD) – Goldman Sachs
  • Lexmark (LXK) – Goldman Sachs
  • analogue Devices (ADI) – Target and estimates cut at UBS

Long positions in stocks mentioned: IBM

For more of Mr. Moenning’s thoughts and research, visit StateoftheMarkets.com

 

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. Stocks should always consult an investment professional before making any investment.

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