Weekly Update

By: Jim Patterson | Wed, Jan 23, 2008
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Weekly hotline Update #51 - 01-23-08
1/23/2008 9:36:16 AM

Over the past week (5 trading days) the Dow has fallen over 800 points, about 6.3%. On a point basis, there are only eleven 5 trading day periods when the Dow fell 800 or more points. And about half of those were in 2002. On a percentage basis though, there are over 300 times when a five day decline was more than -6.3%. Bottom line, it has been a dreadful week for the market, but there has been worse.

One week ago I discussed the negative start for the market and the forward looking implications it carried. The fact things have progresses so quickly so much lower is of grave concern. Our daily work produces a number of signal metrics. One I developed a long time ago is called the Rare Buy Signal. It is based on the acceleration and deceleration of relative up and down volume metrics. Bottom line, Rare Buy signals are not given very often and are only given when the market has reached an unsustainable condition of downside acceleration, which is common at very important lows.

In total the series has about a 65% win rate, with the bulk of the negative signals coming "too early" before the important low is reached. As the market accelerates into an important low it is common for multiple signals to trigger over a period of days creating clusters of signals. Over the weekend I did some extensive research on the number of signals given during the 20 trading days prior to a very important low. The chart below details the results.

Since 1993 there are 18 major lows. On average, 5.5 Rare Buy signals had been given in the 20 trading days prior to the low close for the S&P 500. In only three instances had three or only two rare buy signals been given prior to the low. Note: all three were rather minor lows.

With the S&P 500 down 16% from its 60-trading day high, when or where ever the low develops it will go down as one of the four biggest of the past 14 years. The number of Rare Buy Signals at the major lows was 8. At present we have only 3.

Anything can happen, but at present we have a market that is going down hard and fast and the too many folks are looking for the bounce. As a result our Rare Buy signals are not firing as they should. I expected a fourth signal to fire on Tuesday, but because the market rebounded so much over the second half of the day, no signal was given.

In order for a major low to develop, we need to see some actual market panic. At present, while it may seem like we have seen some panic, relatively speaking, no one is panicking. Until they do, it is doubtful the important low we are all looking for will develop.

If you take a look at the daily put/call ratios, a pattern of lower peak levels has developed as the decline has progressed. This is a-typical behavior and underscores the idea that many folks are looking to "catch" the bottom. History has proven that a stopped clock is right at least once per day, but that does not make it reliable by any means.

Seriously folks; the market is due for some sort of rebound, but at this time any rebound that develops is expected to be just that, a rebound. The rebound may be short lasting only three to five days or it may last for several weeks. Whether long or short, the market must come to grips with the idea that simply taking a charge against earnings for problems related to a companies poor execution or decision making simply does not accomplish the sort of market cleansing that takes place over a protracted bear market when the loss of earnings potential is acknowledged.

That said, the one thing we do know is that once the selling has run its course a new bull move will develop. As long as we are patient, we should have plenty of powder dry once we can confirm an important low is in place. Ideally we will see a number of Rare Buy signals given at some point in the weeks ahead. The downside to that thought is that for them to be given the major indices are likely to fall to measurably lower levels after the over due rebound.

Turning to the 12-month PRS Time Plane, this is about as bad as it gets. Since 1996, the only periods of decline similar in magnitude are 1998 and the late 2002 / spring 2003 lows. The 12-month plane is shown while the three month and six month graphics convey essentially the same message. A notable similarity is that the 90th percentile is now in line with the major lows at all time frames.

The real problem evolves when considering both arguments in unison. The market's performance is in line with its two worst periods over the past 12 years. However, at those lows we had six to ten rare buy signals as the market powered into the low. I remember them well, and folks were really bearish. Now here we are again yet the raining sentiment seems to be that the end of the decline is virtually upon us, which in fact is unlikely.

A rally of some sort is brewing and ideally it will last for one to three weeks. But at the end of the day, we are confronted with problems that will not be quickly remedied by taking a charge or write off. Companies are going to have to work through systemic problems and that takes time.

New Entries for January: Over the past week a number of stocks have moved into our entry criteria zone. Needless to say, they all look dreadful. However, these are market leaders that have the potential to quickly rebound once the market regains its footing. Bottom line, even though the market is over due for a bounce, I am not enthusiastic about buying anything at this time.

The following stocks have been removed from the Open Active Table: EXPE, ICE, KCI, and GSOL.

TASR will be removed if it weakens further.

The Table below lists fifteen of our top Open Active Recommendations:

Portfolio Update: With the market in a challenging state, nearly all stocks are getting hammered. However, after five consecutive heavy down days, history suggests now is not the time to aggressively sell stocks. We are not ready to buy anything just yet either. A rebound should develop by the end of the month that allows for more attractive prices at when to sell.

Portfolio #1:

Portfolio #2:

The selling has not fully run its course. However, we should be getting close. Our PRS Time Plane metrics are near their lowest levels ever over the past 15 years. That alone is suggestive of a pending rebound. The current oversold condition is mitigated by the lack of "panic" like behavior, which is reflected by the lack of Rare Buy Signals triggering at this time of crisis. In short, too many people are in agreement with the assessment that a rebound is very close at hand, which will be sharp and allow much better exit points. And, if prices truly firm up the potential for an extremely attractive entry point developing is difficult to resist.

The downside is that at this time it is our belief that any near-term rally, whether 3 days or 3 weeks, will prove temporary as the issues driving the market lower are deep rooted and systemic in nature, thus they will not quickly be written off.

"Men's best successes come after their disappointments." - Henry Ward Beecher



Jim Patterson

Author: Jim Patterson

Jim Patterson
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