Stocks Stage An Impressive Reversal Off The Morning Lows; Stock Indexes Close Red, Across The Board

March 2, 2007

Stocks started off the day with a nasty replay of the action on Tuesday. However, stocks found support shortly after and managed to rally to a respectable close, helping rescue trapped longs. Early weakness caused by a selloff in Asian and European markets (China down 2.8%) and inflation worries quickly sent stocks for a loop. The core personal consumption price expenditure index rose .3%, giving it a year over year increase of 2.3%. That is ahead of the Fed’s target 1-2%. But shortly after that nasty gap down, the ISM manufacturing index came in with a 52.3 reading, above the neutral 50 level. This and a heavy round of short-covering sent the indexes higher and even sent them into the green. But in the final hour, sellers reasserted control, ending the hopeful wishes of a green close by the bulls.

At the close, the NYSE led to the downside with a .6% loss, the Nasdaq followed with a .5% loss, reversing a 2.3% loss earlier in the day, and the DJIA, SP 500, and the SP 600 all finished .3% lower. The IBD 100 did not fare well, falling .4% and finishing lower for the sixth day in the last seven sessions.

Volume was lower on the NYSE but was higher on the Nasdaq. The higher volume, technically, gives the Nassy another distribution day but it was a weak one. Remember, distribution days really don’t matter any more as the market is in a confirmed correction. I am watching distribution days now to tell me if this correction is going to turn into a bear market. If it turns into a full bear market, then I will be able to start operating on the short side. Until then, it is strictly gambling and emotional trading; I don’t play either one of those games.

The stand-out stat of the day, for me, today, is the advance/decline line. The NYSE and Nasdaq both saw some nasty breadth to start the day. Both were near 4-to-1 negative. However, by the end, decliners beat advancers on the NYSE by a 10-to-7 margin and by a 2-to-1 margin on the Nasdaq. Considering how much the market finished off the lows, you would think breadth would have caught up. Instead, breadth remained much weaker than what the final figures on the indexes show.

There were some more signs of weakness/caution that popped up today on my radar (these are really starting to outnumber the positive signs). The first thing catching my attention today is the new list of Your Weekly Review in IBD. There were a total of 120 stocks on the list this week, compared to 144 last week. That means the Tuesday damage and further losses today resulted in 24 stocks coming off the list. If this were a simple selloff and a rotation was happening, I truly doubt 24 stocks would have fallen off. More than likely 24 would have fallen off and 10 to 20 stocks would have been added. Instead stocks fell off the list and few were added.

The second thing is the fact that the top two industry groups in IBD had big losses. With the market down less than 1% and the top two sectors getting rocked for 2% losses it is clear the big boys are starting to dump the old leaders. Steel-Specialty Alloy and Chemical-Fertilizers have normally held up well on down days. Once again, just like on Tuesday, they suffered some of the biggest losses. To go along with this, the top stocks today were the laggard machinery and home builders, and the ever famous for rallying in bear markets group–the HMO stocks.

The third negative is the Accumulation/Distribution ratings on the market indexes. The IBD 100 index now has a D+, the SP 500 has a C, and the Nasdaq and IBD New America index have a C+. These ratings have dropped like a stone, since the Tuesday selloff and until they climb back to the A and/or B level it is smart to avoid going long the market right now. When the market bottomed in March 2003 following the horrible bear market, the NYSE, Nasdaq, and IBD 100 all had B+ or higher ratings. Even if the market was in an uptrend and the ratings were a C, if it came from a D or F rating that would be good. Going from an A and B to a C and D, in three days, is very bearish for the intermediate term.

Let’s go over some of the positives. The impressive rally off the huge losses in the morning has to be taken as very good news for the bulls. The fact that we did not follow-through on that panic selling and closed near the HOD on the indexes has to give some comfort to those trapped bulls that believe a rally is going to shape up soon. The argument for that could be the put/call ratio. This ratio continues to hover over the 1 level and now stands at 1.24 for the equity put/call ratio. This is supposed to show that there is a good amount of fear in the market. However, I am not sure if this indicator should be trusted after such a huge uptrend. If this selloff was coming after a 15-20% loss, then I would definitely interpret this as bullish. However, I simply can not see how this indicator can be bullish considering the damage I have on my individual stock charts. But the indicator is high and a five to ten day rally shouldn’t surprise anyone.

Right now the market is trying to find a solid area of support, in the short term. Regaining some calm over this wild and crazy action is probably what the market is trying to do here. The SP 500 is down 4% and the Nasdaq is down 5% since hitting highs not too long ago and all the gains since December 4, 2006 have been erased in a matter of three market sessions. This is definitely having a major psychological effect on investors and traders. The market will probably continue to be choppy here as traders figure out if all those gains that have been wiped out are going to be coming back any time soon. This nervousness will probably cause some wild swings in the market the next few days to weeks.

Remember, things have changed out there. Cutting your losses faster on stocks not moving up immediately is way more important than letting a simple pullback works its way out for more gains. Normally in bull markets, if I go long a stock and it does not go up immediately, I will hold on to let it gather some momo as long as it does not violate support of the base it is breaking out of. In market environments like this it is best to cut 25-50% of a new long immediately if it is not up the next day. 3 out of 4 stocks follow the market and if the market is not going up, chances are your stock is not going to go up either. So remember in this market, your stock either goes up immediately after you buy it or you dump 25-50% if it does not. And if it drops on higher volume than the breakout day yet does not violate support, consider selling 50-75%.

Be careful out there. This market right now has all the classic signs of an oversold bounce. Besides an oversold bounce, I don’t believe we are going to get much here. I don’t trust rallies here and I believe that it is best to protect profits and if I traded like a daytrader I would want to now short the rallies and cover on the dips. Before Tuesday, it was buy the dips and sell the rallies. I believe that game is over, for now.

Aloha and I will see you in the chat room.