This is a market that's at a tipping point -- balanced between hope and fear.
The problem with range-bound markets is that there isn't enough real information to give either emotion a significant edge. Hope that things are getting better drives stocks up, but fear that things aren't as good as they seem sends stocks back down.
If this market is range-bound, we're going to see rallies fail at 1430 on the
, 8500 on the
Dow Jones Industrial Average
and 900 on the
. And we'll see the dips contained at 1270 on the Nasdaq, 7800 on the Dow and 800 on the S&P.
That wouldn't be a disaster. Building investor confidence that the market isn't about to drop another 20% or 30% is a requirement to ending the bear market -- or at least this stage of it. And stocks need to spend some time building exactly this kind of base to create a foundation for any kind of advance that lasts more than a few months.
While a range-bound market would be a disappointment for those investors who are very bullish or very bearish, it does generate plenty of opportunity for profits and losses even if the indexes finish with a wash. Any investor who buys at one of these temporary tops and then panics into selling at one of these temporary bottoms can be whipsawed into considerable losses. And any investor who can buy low and sell high (or short high and cover low for shorts), maybe even repeating the same modestly profitable trade over and over again, can rack up solid profits in a market that's going nowhere.
Right now I think it's impossible to tell with real certainty that this is a range-bound market. The evidence is just too ambiguous.
On the one hand, the stock market is retreating for resistance and advancing from support in just the way that a trading-range market would. For example, on April 7, stocks stalled at 1430 on the Nasdaq and 8500 on the Dow before fading to a slight gain at the close. Those levels roughly mark the stock market's 2003 highs in January and March. Stocks don't show an inclination to break above those points.
The 1423-1430 level on the Nasdaq, for example, was the floor for that index in the aftermath of Sept. 11 and in the market lows of October 1998. It was also the high reached in the August 2002 rally. Now it seems to be acting as a barrier to the technology-dominated Nasdaq. Similarly, the Nasdaq Composite bottomed at 1271 on March 11 and at 1279 on Feb. 12.
This isn't to say that these levels are guaranteed prices. Think of it this way: On recent experience, when the index is at 1270 or so, investors can reasonably conclude that stocks are relatively cheap given the lower risk and that the market has turned at this level twice before. At 1270 or so on the Nasdaq, investors have appeared willing to buy.
But at 1430, stocks seem relatively expensive given the market's recent history of selling off at this level. The risk at 1430 is high enough so that selling in order to take profits makes sense.
The Way of the Range
There are all kinds of ways to define the range right now, but the message is pretty much the same: Lacking conviction, investors take profits as soon as they materialize. And they look to re-enter the market when prices sink to a level that shifts the risk/reward ratio back to the side of reward. That lack of conviction is supported by the light-to-moderate trading volume in the market even on big news days.
But before you conclude that the case for the trading range is open and shut, you ought to note that some pretty good technicians have come to very different conclusions.
Phil Erlanger, editor of
Erlanger Squeeze Play
and one of my colleague Jon Markman's favorite market-timers, for example, has what he calls "zero buy confidence" in the Nasdaq and not much more confidence in the S&P 500. The market is setting itself up for a decline from current levels because investors are overconfident.
On the other hand, Dan Sullivan, editor of
market-timing newsletter, moved back into the market on April 10, ending his 100% cash position. Sullivan's reasons included the strength of the March rally. He noted that most bull markets start with a powerful upward thrust, and the eight-day March rally was the most powerful move upward since 1896, according to Sullivan's research.
Sullivan also cited the behavior of the high-relative-strength stocks that have led the market higher. Rather than rolling over as they've hit 52-week highs, many of these stocks have continued to lead the market, providing the leadership that any market needs in order to rally.
A Precarious Balance
The convincing cases that can be made for all three points of view point out, to me, how precariously balanced this market is. Events -- especially quarterly earnings reports -- will tip it one way or the other in the short term. The stock market's reaction over the next day or two to
earnings report will be key.
Also, if bad earnings news from other companies (and nobody is expecting anything much good out of this war-worried quarter) doesn't take out the bottom of the trading ranges, that will go a long way to turning the trading-range opinion into a market consensus.
Don't underestimate the way that a consensus in favor of a trading-range market can become a self-fulfilling prophecy. If everyone thinks it's safe to buy at 1270, it probably will be safe to buy there because the consensus itself will bring out the buyers.
To get more insight into the direction of the market, I'd suggest you take a couple of weeks to see how prices respond to the expected bad earnings news. (And also to see if any unexpected bad news emerges that could take the floor out from underneath this market.)
And then, if it still looks like this market is holding its recent trading range, you can start dividing stocks into two groups.
Look for Momentum
There will be those, like Sullivan's high-relative-strength stocks, which seem determined to climb higher. Watch closely to see if these stocks maintain their momentum through any earnings-season pullback and downgrades that analysts' slap on stocks near a high in a trading-range market. If they do, it's possible this group will be able to provide the leadership needed to take the stock market back up to the top of the trading range at least -- and maybe further. Continue to monitor this group to determine if stocks can push through the higher range.
Here are some high-relative-strength stocks worth watching as indicators:
has refused to pull back with the general market or retreat, even as the company sold more shares in a secondary offering.
has been creeping back from the hit it took on April 7 when J.P. Morgan downgraded the stock, up 80% in the last six months, to neutral on valuation.
has climbed 24% in the last six months and 11% in the year to date despite the pullback in energy stocks on the collapse of oil prices.
Whole Foods Market
( WFMI) has pulled back only slightly after hitting a new 52-week high in early April.
If the stock market moves strongly higher after earnings season, taking out the top of the range, these stocks should continue their advance.
But investors might find a better combination of risk and reward in finding stocks that have retreated from the top of their range but still show solid strength in the recent market. These stocks show the price action that's likely to endear them in the early going to investors who believe this is a range-bound market.
The following names are particularly attractive because they are able to demonstrate earnings, revenue or cash-flow growth combined with a strong balance sheet. Here are the stocks I put in this group.
pulled back from a high of $44, but has shown solid progress recently in moving off lows near $37.
is below its year-to-date high of $26, but has shown impressive strength in moving up from its low of $18.70.
( WMI) bottomed just below $20 after a year-to-date high of $24.
looks like it's rebounding from the recent pullback in the energy sector.
Of these, I think it's worth waiting on Xilinx for Microsoft's and other tech earnings reports; on Waste Management for a clearer trend; and on EnCana for the potential for more Iraq-related drops in energy prices.
But I'm going to add PepsiCo to Jubak's Picks here. The company isn't likely to be affected by anything negative that happens in the technology or energy sector, and in fact might actually climb as investors interested in increasing their equity exposure opt for relative safety.
Jim Jubak appears Wednesdays on CNBC's "Business Center" at 6 p.m. EST. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: EnCana, PepsiCo and Whole Foods Market. He does not own short positions in any stock mentioned in this column.