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This is the time of year where everyone gives out stock market
forecasts and this year in particular they are all over the map. David Bianco
of UBS AG is calling for a 53% rally for the S&P 500 in 2009. He claims
that the first "signs of a dawn of confidence" will cause a total
surge in stock prices thanks to cheap valuations and Fed intervention. On the
other hand regular CNBC talking head Vince Farrell thinks that "the
stock market will take its time forming a bottom - at best. Damage like we
have seen takes months to repair."
I'm not
going to go out on a limb here and make a guess of how high or how low the
stock market is going to go. I just don't see that as a productive game and
really know one can know that. I have a plan on how I plan to navigate the
market this coming year and an assumption on exactly what the market is going
to do is not a factor in my plan.
The most
important thing you need to do to make money in the stock market is simple -
align yourself with the primary trend of the market. That means recognizing
what the current trend of the market is, knowing when it changes, and then
making the proper adjustments when it does change.
It sounds
easy, but if 2008 taught us anything it is that very few people do this. Not
only did the public get crushed in a bear market they didn't foresee, but so
did thousands of mutual fund and hedge fund managers. Most brokers and
investment advisor sat like a deer in headlights as the market went lower
too. The professionals turned out to be no better than the amateurs, and in
some cases they turned out to be total crooks. The person who recognized the
reality of the bear market for what it was and then took the appropriate
investment stance was the rare bird.
In fact
most people actually tried to fight reality and come up with wild
rationalizations to justify doing so. In the beginning of the year just about
everyone thought Bernanke was going to save us, or simply couldn't believe
anymore banks could go broke after Bear Stearns did. Those thinking that
ignored the crime of Level III assets which meant that most banks were
bankrupt. I know Level III isn't a crime but it should have been. Thank you
SEC and the lobbyists who bought the politicians sitting on the banking
committee. In the summer as the market rallied a popular theory held that the
market would blast off once oil prices dropped. And then in the Fall many
held on to the belief that Hank Paulson's bailout would save the market. After
it passed the market crashed anyway. Now most people expect a big rally,
because the market has simply fallen so much.
In all of
this talk we have seen in this past year what most of it consisted of was
ignoring the big negative trend staring all of us in the face. The market was
in a bear market and most people just sat on their hands as it ate their
money away. They were too scared to sale, because they feared that if they
sold the market would go up without them and make their neighbors rich.
If they
would have focused on the big trends of the charts they would not have made
this mistake. In 2008 the stock market consistently made lower lows and lower
highs as every single rally peaked at a lower level than the previous one and
then led to a nasty correction. All of this of course happened with the major
market averages below their long-term 150 and 200-day moving averages in a
classic stage four bear market decline.
If 2008
was the year of the bear market then 2007 marked a transition period out of
the cyclical bull market that began in 2003 and into last year's bear market.
Most sectors and stocks went into a bear market way before the broad market
averages did in 2007. As you can see from the above chart the NYSE
advance/decline line peaked out over six months ahead of the DOW and S&P
500 top in October 2007. The individual sectors themselves were actually even
worse.
Between
October 2007 and December 2007 I wrote articles warning people that a full
blown bear market was upon us and that they had to do whatever they needed to
do to adjust to that reality.
In
December 2007 I said in an article,
"the Worden Brothers TC2007 software breaks the market up into 239
sectors. Since January 1st until today, 110 out of 239 sectors are
underperforming the market. Eighty-seven sectors are in the red, despite the
S&P 500 still having a gain for the year. Most of these sectors are so
far below their 150-day moving averages that those moving averages are
already sloping down. In other words 36% of the stock market is already in a
bear market." The transition from bull to bear had been completed.
My point
in this isn't to show how I was right in December of 2007, but to show that
we are in a similar moment right now. It was clear a year ago that we were in
a new bear market and to make money in 2008 would require a new set of
tactics. Now it isn't clear that we are in a bull market now - hardly - but
2009 is going to be different than 2008 and will require new ideas and
strategies that we didn't use in 2008 to make money.
I see
2009 to be similar to what we saw in 2007 in the sense that it will be a
period of transition. This time though we will see a stage one transition
phase between a bear and bull market. In 2007 most stocks peaked out ahead of
the market and went into bear markets before the market averages did.
Right now
it is obvious to everyone that we have had a brutal bear market. What happens
after a bear market though isn't so obvious to those that obsess over mutual
fund holdings, CNBC, or myopically focus on the market averages - which has
actually been an important thing to do this year.
A stage
one transition phase can last anywhere from 3 to 12 months once it gets
started. During the transition phase though most sectors firm up ahead of the
broad market averages and a few actually enter bull markets of their own. This
causes the NYSE advance/decline line to create a positive divergence from the
broad market averages as the consolidation period nears its end.
For
instance after the 2002 bear market bottom the three major market averages
entered a nine month stage one consolidation phase that paved the way for a
new bull market. However, the NYSE advance/decline broke away from the
averages to create a positive divergence about halfway through the phase. When
you broke down the sectors many sectors had actually began their
consolidation phases ahead of the averages and began bull markets of their
own ahead of the market too.
Just like
when the sector action and advance/decline line warned that we were
witnessing a transition period between bull and bear in 2007 the action said
a bull market was ahead in 2002 and early 2003.
I expect
the same thing to happen again. For the past year I have really focused on
the market averages, my best trades being taking short positions against them
a few times in 2008. It will still be important to pay attention to them over
the next few months, but the important thing to watch in 2009 will be the
sector rotation and advance/decline line.
I see
2009 to shake up to be a year of transition much like the nine month
consolidation period in 2002. As this transition period ends there will be a
few sectors that enter bull markets of their own ahead of the broad market. This
is where the money will be made in 2009 - not by trying to guess the bottom
of the S&P 500 and just throwing money at it - but by carefully looking
at the individual sectors of the market and buying into them as they enter
bull markets of their own.
And when
it comes to bull markets I prefer to buy individual stocks rather than just
ETF's. The big money is being made by buying the best stocks that are in the
best sectors just as they begin new bull markets.
This is
what we have to look forward to in 2009. However, right now it is not clear
yet that we have actually seen the final bear market low. For one thing when
I look at the sectors only a few have clearly gone through a quarter of their
stage one consolidation phase. Most sectors made new lows in November and
have simply rallied the past few weeks on low volume. They could simply have
had another bear market rally. If they did bottom they have not based above
that bottom enough in regards to time to be able to say with certainty that
they are going through a stage one consolidation phase.
There is
only one sector that looks like it has the potential to go into a new bull
market in the coming quarter and that is the airline sector. It is the ONLY
sector that appears to be approaching the end of a stage one consolidation
phase. I see only a few other sectors that appear to be halfway through their
consolidation period - mainly regional banks and some construction related
stocks - but as a whole it is not clear that most sectors have even begun
their consolidation periods.
Over half
the sectors will be near the end of consolidation phases as we approach the
beginning of the next bull market. There is only one in this position now.
That means we are not about to start a new bull market - not yet.
In other
words the broad market has not even begun its stage one consolidation phase
yet. That means that we must assume from a risk/reward stand point that the
bear market is not over. Buying based on the assumption that it is the
bottom, because it must be is not a good idea. Many people thought the bear
market ended in March and July because it fell a lot then too and they were
wrong. Lower prices is not enough to just assume the bear is over.
At best
the market is just beginning a stage one consolidation phase. At worse this
is just another bear market rally like we saw in May and August that will
lead to lower prices.
There is
no way to know for such which is the case. What we do know for sure is that
this rally is not the start of a new bull market and that we are going to go
through a period of transition before the next bull market begins - and we
haven't even gone through that process yet. That means it is coming, and will
almost certainly start in 2009.
I am
trying to boil down to you what we KNOW for sure about the market. Instead of
giving you predictions and guesses on the market and speculations on what the
economy is likely to do or what I think it should do I want you to KNOW what
the trend of the market is and what you can expect. I want to stick with
facts and make conclusions based on pure logic in this article. This is the
key to making money - aligning yourself with the dominant market trend and
then adjusting to changes in that trend when they occur.
In 2008
that meant shorting rallies. Once the market goes into a transition phase new
strategies will be needed. Towards the end of the transition phase you will
want to buy the strongest stocks in the strongest sectors poised to go into
new bull markets. Buy the right stocks at the right time and you will double
your money.
That's
what you do towards the end of a consolidation phase. You buy and you buy
big.
We aren't
at that point yet.
Until we
get to that point the market averages will have a down and then sideways
bias. Once this rally ends the next move may be to new lows. Even if the
consolidation period is beginning you can still get new lows. That is what
happened in 2002. And in 2007 when the bull market was nearing an end even
though most sectors were entering bear markets of their own ahead of the
averages the averages had one last hurrah in October 2007. Everyone who
didn't watch the sectors and just watched the averages got their head handed
to them as a result.
Now
during transition phases the markets trade in a trading range, in which the
market tends to top out at a defined resistance point and then trade down to
form a new support level. If the market bottomed in November that topping
point would most likely be in the 1,000 - 1,050 area of the S&P 500. For
me the easiest way to make money in bear markets and in the first 1/2 of a
stage one consolidation phase is to short the rallies when they come to an end.
Going
forward for 2009 then the best way I see to make money will be to short the
market averages once/if the S&P 500 rallies above the 1,000 level. If
this rally continues into the first week of January I'd expect it to come to
an end by mid-February at the latest. If we get in on the short side then
cover and take profits on a move back down near the November low.
Then sit
back and see how the sectors evolve. If they still don't perk up short the
next rally. If more of them get into bullish configurations then do the
research on individual stocks and companies with a plan to buy in big. If the
bear market is over then on a retest we'll start to see some sectors stop
falling with the market averages and a positive divergence begin to firm in
the NYSE advance/decline line. That will be a sign that we need to shift our
attention to buying individual stocks in the best sectors to prepare for a
new bull market.
What I am
describing to you is a major shift in strategy - not to happen right at this
exact moment, but at some point next year as it becomes clear we are in a
transition phase. This is the best strategy I know to not only make a lot of
money, but do so safely by buying at the right time, because it adjusts to a
transition phase.
Of course
this philosophy means you will not buy on the exact bottom of the bear
market. But I don't care about that. I want to buy into the best stocks in
the best sectors and then watch them immediately enter bull markets and make
me a lot of money. Who cares about trying to guess the exact bottom when I
can double my money without much worry at all. I don't like to buy and pray.
That's a game for mutual fund managers who obsess over index benchmarking and
are more interested in making sure they stay in pace with benchmarks than
they do in making a lot of money and the general public who don't know what
they are doing.
Neither
of these groups of investors though adjust at all to changing market
conditions. That's why they just sat there and got wiped out in 2008 and
really won't fully take advantage of the opportunities that will come in
2009.
Yes the
bear market may have another leg to it once this rally ends. I know the
economy is bad and is likely to get worse. Next year may turn out to be the
worst year of our lives when it comes to the economy. But even if that is the
case I still expect the stock market to begin this transition and that will
mean some of the best opportunities to make money in the market are ahead of
us in 2009. It will be an exciting year for us when it comes to the stock
market. When a market has one of the worst bear markets ever there are great
opportunities that line up.
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Mike Swanson
Editor,
Wall Street Window
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