Waiting for the market’s other shoe to drop

   Date:2011/08/19

LOS ANGELES (MarketWatch) -- Stocks were treading water Wednesday, as market participants showed caution for the second day in a row. Uncertainty is being manifested by the reduced volume, as some players wait to see if the other shoe drops.

If share moves are to be taken seriously, the first order of the day would be a follow-through in one of the major averages. Bill O’Neil originated the follow-through day (FTD) concept as an objective means of determining whether institutional investors had begun to return to the market following a correction or bear market.

 The basic idea: Following a substantial decline in the averages (8%-12%, for example), the first three days should be ignored. Beginning with the fourth day, should at least one of the major averages rise a substantial amount on volume that is higher than that of the previous day, a FTD is said to occur. Read more on Wednesday's near break-even stock trading.

The view here is that too many participants place too much blind faith in the FTD concept, and treat it as some sort of magical elixir.

Unfortunately, the market is not that pat. The action of the leading stocks should also be factored into the equation in order to determine the probability of a successful campaign of intermediate-term speculation. Other tangibles, such as the depth of the previous decline in the averages and the age of the bull market (if shares are in a bull) should also be examined.

The FTD does serve a purpose, and that is as one of the first signposts, if not the first, pointing the way to a possible advance over the ensuing intermediate-term.

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/conga/story/misc/investing.html 163344 Short-term, the market does not have time on its side. A seasonal slowdown in trading activity due to vacationing participants kicks in over the next three weeks. This does not favor the probability of institutions stepping up their purchases of stock anytime soon. Moreover, September has historically been a treacherous month. On the plus side, the September-October period has served as the launch pad for a number of bull markets over the years, including four of the past five.

This column pays little attention to so-called support levels in the equity averages. These are far less reliable than support levels in individual stocks. Therefore, the view here is that they provide little benefit when making an investment decision.

For students of intermediate-term price action, the takeaway of the short-lived June-July rally in the averages was this: Always pay attention to market volume in an advance in the averages. When it is not there, be suspicious. They do not ring a bell at the top, but at least one can be aware of some things to look for that will provide an objective view of market health, and adjust exposure, if any, accordingly.

Using the 1987 model, the averages can be expected to show wider-than-normal swings for the next few weeks/months. Leadership following Black Monday changed to defensive issues. They led in 1988 and 1989. Coca-Cola Co., Bristol-Myers Squibb Co., Gillette, Glaxo Holdings, Merck & Co. , Philip Morris International Inc., Procter & Gamble Co., etc. had high relative price strength. And 1989 was a good year for the market. Therefore, the leadership change seen recently into defensive and/or higher dividend-paying titles in itself does not mean a bear market, or even cheaper quotations, is imminent.

One of the best indicators of a market being on the cusp of a new intermediate-term advance or new bull market is simply the way growth stocks act. Are they in down trends, moving sideways, or in up trends?

(A growth stock is the stock of a company whose business is largely recession-resistant and whose earnings are growing faster than those of the average company. This column’s focus is on those companies growing earnings at least twice the long-term average of 8% per annum, and preferably, 20%-plus. These have historically been the market’s biggest-winning titles.)

This type of general market analysis is not proprietary, is not the domain of high-priced research analysts whose objectivity may be questionable, and does not rely upon a subjective opinion of the economy.

What it shows is that institutions with a mandate to own growth stocks are not committing capital to their favorite sons and daughters as they would normally be expected.

Baidu Inc.is a stock that, along with Apple Inc. , typifies the kind of must-own stock that a growth-oriented institution will own in a bull market. In the below chart, the stock breaks out of a consolidation area known as a base. Shortly thereafter, BIDU is dumped by institutions on elevated volume. This is known as a failed breakout. What is telling is the renewed selling of Monday and Tuesday, which the chart shows as occurring on two large red volume bars.

Source:Kevin Marder

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