The Oversold Bounce I Expected Arrived Earlier Than Anticipated; Big Gains Come On Lower Volume

March 6, 2007

Stocks staged an extremely strong rally, off the back of an overnight rally in Asia and Europe. But the big log-jam higher came during comments by Ben arguing for more regulation over the mortgage giants FNM and FRE. Stocks were pulling back slightly ahead of those comments. However, that being a reason for the rally is hogwash. The reason was that stocks were beaten a lot over a very short period of time and a very powerful oversold bounce was to be expected. There was a bit of bad econ news today out of the factory orders. Orders fell 5.6%, below economist expectations and coming in with the worst drop since July 2000. This had no effect on the market, as can be seen below, as all stock indexes recouped all of Monday’s losses.

When the closing bell rang, the SP 600 led the way higher with a 2.1% gain, the Nasdaq and the NYSE followed with 1.9% gains, the SP 400 and SP 500 finished higher by 1.6% and 1.5%, and the DJIA lagged the other indexes with a 1.3% gain. The IBD 100 led outdid the rest of the market, with a 2.9% gain. However, the relative strength of today’s gain in comparison to how much it led on the days that it led to the downside leaves much to be desired.

Even though those price gains look beyond impressive, there was something missing; volume. Volume was lower on both the NYSE and the Nasdaq. There is nothing wrong with that except normally on big up days you like to see volume much higher than on the days where stocks dropped. The lower volume indicates the big boys were not eager to buy stocks at these levels. To me it looks more like a big short squeeze jam, for now.

Breadth was very positive, on both stock exchanges, today. 196 out of 197 IBD industry groups were either higher or flat today (only the Metal Prod-Fasteners group was down). Advancers beat decliners by a near 5-to-1 ratio on the NYSE and by a 4-to-1 ratio on the Nasdaq. This, to me, seems very extreme and is not something I am used to seeing at bottoms (if this is going to become a bottom). That is just something to keep in mind. Especially considering that new lows beat new highs today, by 85 to 79. More new 52-week lows than 52-week highs, and we had 4/5-to-1 positive breadth and are less than 10% off the highs? That seems like negative divergence to me. Just another “warning flag” on this rally being possibly nothing more than an oversold rally.

The fact, also, that the top three groups were Banks-Foreign (up 4.7%), Steel-Specialty Alloy (up 4.5%), and Metal Prod-Distr (up 4.4%) show that this rally is probably not the start of the real deal based on the thesis that old leaders do not lead new bull market cycles. If this is a bottom, then we have some poor leadership of past winners that have many many charts broken and/or destroyed. The fact is the stocks in these groups ALL have UGLY charts. The whole lot of them. They are all ugly. You do not see that with new leaders in new bull markets.

Tuesday was the first day of an attempted stock market rally. We now need to see some big gains on MUCH HIGHER VOLUME within the next four to ten trading days to start feeling more safe going back in on the long side. However, a follow-through does not guarantee we are out of the woods yet. The damage to these index charts are HUGE and there are UGLY charts everywhere. These normally need weeks and weeks if not months and months to fix themselves. Also unless the follow-through is on a gain of 1.7% or more with HUGE volume, I would not be too comfortable with the gains. You also do not want to see the market undercut the recent lows before we see these gains. If the major market indexes break their recent lows by even .10, the rally attempt is dead.

The one statistic everyone is talking about (and now IBD is also) is the put/call ratio. Yes, that ratio does indicate that players are making very bearish bets. However, the total ratio now stands at 1.22 which is down from the 1.8 area before the selloff started. Still though this indicator is a big head-scratcher. If this reading was happening after a long downtrend, I would take it as very bullish. However, the high number before the selloff and a still high number now is just confusing to me. I think it may help with this short squeeze rally. However, if this market is only being held up by short sellers being squeezed, when this rally does fizzle out (if it does) it could get ugly. Bottom line: let the price and volume action of the indexes be your guide during this volatile period. Let this indicator die. I know I am going to start not talking about this indicator for a while, unless something shocking happens to it.

Do not be quick to buy this bounce. Don’t expect that this rally will fail and don’t expect this rally to succeed. If you do that and prepare for either outcome you will be way ahead of the game. Trust me, most people, simply can not do this. However, this is necessary during the current market. You simply do not know and NOBODY knows what is going to happen next. Today shows why it is not smart to chase performance. After Monday, a lot of traders, thought now it was a “for sure” time to short the market as it really cracked open. Wrong. Once again, the market, does the opposite of what everyone expects. The best time to short is if the rally in stocks fails near resistance or their 50/200 dmas on low volume. If after a low volume rally you start to see your stock selloff again that is your clear signal to short that stock. Make sure it doesn’t pay a dividend and make sure it is breaking down on HUGE volume and the low volume rally is on very low volume. This will help increase your odds of being right on the short side.

Also in this market environment, I am sure you sold a stock that you have now seen rally back and then some (ROCM FTGX). Big deal!! If your chart broke critical support and you sold to protect yourself from further losses but that stock has rallied back, don’t worry about it. You did the right thing. When I look at ROCM or FTGX, for example, I now see very ugly chart patterns that I would not want to be long if I was going to be making a new buy. Unless, that chart is perfect, move on. Keep your money in your best performing stocks in this environment and don’t worry if you sell a stock and it rallies back some. More often than not they turn out to be like ITMN. If the chart is ugly, get rid of it. If you are shown a loss, get rid of it, until the market fixes itself.

Remember, everyone, CASH IS KING!!!!!! Until this market calms down and all the emotional tug and war is out of this market, cash is your best friend. The market will take shape, soon enough. If it is to the upside or downside does not matter to me. As long as the trend is clear and in place. Right now, there is no trend. It is volatile and choppy. I am still leaning with my bearish bias, due to all the UGLY UGLY charts out there. But no matter what happens, I am ready.

The Oversold Bounce I Expected Arrived Earlier Than Anticipated; Big Gains Come On Lower Volume

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