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If the amount of email I received after
Wednesday's column was any indication, there was some confusion about my contention that the market's base-building process is only about 2 months old. The confusion seemed to lie with my other assertion that the major averages had a better-than-even chance of eclipsing July's lows.
The most common question was: "How can we build a base when the market is still heading lower?" Let me explain. The process of building a base is a work in progress, but it has to start somewhere. The prolonged downward trend of the past two years accelerated in June, culminating in July's blow-off low. We also saw this happen in the aftermath of Sept. 11.The "stair-step" downtrend is pretty clear to see. Because hindsight is 20/20, we can see that the post-Sept. 11 selloff was just another step in the stairway.
But the most recent selloff is different. At some point, valuations become attractive to value investors (as opposed to fast-money trader types). I think the S&P 500 is approaching that
level because the economy isn't necessarily getting worse -- it's just not growing very fast.The support trend line ("Trend Line of Value") that really began during the early 1980s remained valid until 1995, when the S&P began trading along a steeper support trend line ("Trend Line of Growth"). But the
long-term trend of the market is influenced more by economic growth factors. Nice, steady growth makes for a nice, gentle bull market.
However, the birth of the Internet, among other reasons, spawned an era that really took us away from value and into short-term trends dominated by fear, greed -- and page views. The long-term investor gave way to the short-term trader.
Here's the weekly chart of the
In this short-term arena, hope and optimism reign supreme. So current valuations were ignored, and we instead looked to the distant future -- to infinity, for some stocks -- when the underlying companies of the four-letter highfliers (i.e., Internet stocks) would finally earn enough money to justify
But that all changed in March 2000. Since then, hope and optimism have been about the only factors that have propped up this market as it stubbornly dives back toward the value arena. So just as 1995 witnessed a changing of the guard -- from value to growth -- so did 2000 witness yet another shift from growth back to value. Those who ignored the shifts underperformed the S&P on the way up and mimicked it (and probably went out of business) on the way back down.
So where does that leave us now? Look again at the last chart. My suspicion is that the S&P 500 will steadily wind its way back to the Trend Line of Value, being periodically interrupted by bouts of hope and optimism. With each countertrend rally, a new batch of bulls will snort and stamp their hooves, but the numbers won't lie. The market will say, "Yes, many companies are doing well, but present stock prices are still too expensive." And the trend will continue downward. All the while, the pages on the calendar keep turning.
Ultimately, the base probably will be completed somewhere around 2005 or 2006, and that long-term Trend Line of Value will once again be the predominant trend. The new bull market will have begun.
Assuming I am correct (and opinions will certainly vary), what are we to do? First, there is
opportunity in the market, regardless of direction. But every investor or trader should have a methodology that works in the current market environment. Today's market is a different animal than most of us have ever dealt with before, so different rules apply.
Here are some suggestions:
- Let the "buy and hold" game give way to "sell and hold." Short positions should be viewed as investments, while long positions should be seen as trades.
Become comfortable with swing trading. Use technical analysis to identify trading ranges. Chart analysis always trumps fundamental analysis when it comes to short-term trades.
Learn to short stocks. If you aren't comfortable shorting stocks, buy puts or write bear call spreads.
Become a better stock-picker. Each day, a new batch of stocks hits a 52-week high. Good stock-pickers can always make money.
Always keep plenty of powder dry. There are times to be fully invested, and there are times to have plenty of cash on hand. In my opinion, now is a time to bump up your cash position.
Yes, there are plenty of opportunities during this base-building process. But you first have to accept the fact that the process has just begun. You may not like it, but you might as well get used to it.
Be careful out there.
Here's a long-term chart of the S&P 500.
Dan Fitzpatrick is an independent trader in stocks and options, and is a member of the Market Technicians Association. He is also the editor of "Technically Speaking," the monthly newsletter published by the MTA. His columns focus on quantitative strategies for trading and investing. At time of publication, Fitzpatrick held no position in any stocks mentioned, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Fitzpatrick cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to