Market Comment

The Bounce

August 14, 2011 6:16 am ET

“The farther backward you look, the farther forward you can see.”

— Sir Winston Churchill

Shares are entitled to a bounce from what has been the third-steepest, nine-day descent in at least the past 49 years. The recent thrashing is in good company: Only Black Monday and the October ’08 bloodbath were more severe.

The below chart shows volume drying as prices recovered last week. We would, however, caution against reading anything into the four-day recovery. When you see such a high-magnitude decline, you are going to have a bounce. After a lengthy rainstorm, the clouds will part and the sun will shine. But this says zero about whether the clouds will again produce more stormy weather.

And so it is with the current situation.

Breadth improved as the Industrials sank to a new low. The below chart shows 14% of NYSE issues trading above their 200-day simple moving average last Wednesday (rose-colored price bar, the lowest close of the decline). Despite the lower close in the Industrials, more stocks traded above their 200-day than the 7% of the previous low close day two days prior (aqua-colored price bar).

From here, the typical sequence is for price to test the low of last week. The test should see price come somewhere in the vicinity of the first low, be accompanied by fewer stocks making 52-week lows, and occur on less volume.

We pay no attention to so-called support levels in the averages. These are far less reliable than support levels in individual stocks, and therefore there is no benefit to using them in an investment decision, in our opinion.

For students of intermediate-term price action, the takeaway of the short-lived June-July rally in the averages was this: Always pay attention to market volume in an advance in the averages. When it is not there, be suspicious. They do not ring a bell at the top, but at least you can be aware of some things to look for that will give you an idea of market health, and prepare accordingly.

Using the ’87 model, the averages can be expected to show wider-than-normal swings for the next few weeks/months. Leadership following Black Monday changed to defensive issues. They led in ’88 and ’89. Coca-Cola, Bristol-Myers, Gillette, Glaxo Holdings, Merck, Philip Morris, Procter & Gamble, etc. had RS ratings of 87 to 95. And ’89 was a good year for the market. Therefore, the leadership change seen over the past week into defensive and/or higher dividend-paying titles in itself does not mean a bear market or even cheaper quotations are imminent.

We benefit from the quote at the top of this report.

We have many times discussed the “broken eggs and tennis balls” concept. After an intermediate-term 8%-12% correction in quotations, or greater, the names that act like tennis balls in their ability to bounce right back to new price highs are normally your leaders on the ensuing advance. The ones that sit there barely able to move off their price lows, the ones that act like broken eggs, are generally not going to be your dynamic leaders on the next advance.

It is to be noted, however, that simply buying the first merchandise that moves into new-high ground is not necessarily the optimal choice. Many times the stocks doing this have a V-shaped pattern to their price charts, which usually does not allow for a healthy cleanout of the bulls, which is the purpose of a correction.

In summation, the averages are in the midst of a to-be-expected bounce which says nothing about whether the Aug. 9 intraday low will be taken out. Leading stocks have not had enough time to build proper bases. This is all we need to know.

Cash is king.

Kevin Marder

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2020 Gil Morales & Company, LLC. All rights reserved.