Are the Markets Ready to Bounce?

The financial markets are both uncertain and stressful. The first quarter rally in stocks brought optimism and hope relative to the outlook for our portfolios. But, since the first of April they have taken back the majority of the gains and left us uncertain of what to expect going forward. Uncertainty is one of the greatest enemies of the market. It invites speculation of what might happen, and then it feeds on the negative as fear rises. But, in the end the fear leads to oversold conditions and buyers bring optimism back to the markets. There was a mild shift in the markets on Tuesday relative to sentiment. The buyers slowly stepped into the market throughout the day. Not in a big way and there was very little fanfare throughout the trading day, but in the end it bounce off the lows and left some hope that a near term low was established.

Don’t get me wrong, the markets are still uncertain, but maybe, just maybe a little less stressed. This may permit a short term opportunity for a bounce off the lows. Yes, I understand what the economic data is stating, and what is going on in Europe. I have read all the reports on the global economic picture. Heck, I have even written about most of the concerns and warned about the risk of the current market environment. That is why our models are predominately in cash. But, the technical data has compiled a significant oversold signal and eventually that creates a stocks are cheap mentality from analyst and traders. One quote I read recently, “stocks are cheaper relative to Treasury bonds than any quarter in almost sixty years.” Value perception is a big buying motivator for individuals. We want to get a bargain, and some believe stocks are deeply discounted currently.

Stocks are cheap fundamentally, but the outlook for growth is the key challenge for prices moving higher. If growth doesn’t exist in the economic picture how will stocks create an environment for a sustainable rise in prices? There in lies the challenge or uncertainty in the markets today. The argument for stocks being cheap is a great reason for owning stocks, but it isn’t a compelling reason in the face of negative sentiment. If and when the outlook shifts the rally that we all want in stocks will materialize and it will do so with conviction.

What are we looking for now?  More of the same. The S&P 500 index found support at the 1267 level on Monday. The move off the low continued on Tuesday with a solid gain on the day. As we head into Wednesday’s trading I expect the bounce to continue. 1300 is the first level of resistance for the index. The downside bias relative to the trend is still in play and the move I am discussing is nothing more than a bounce in the prevailing down trend off the April high. I would look at the bounce as a opportunity to add to or establish short positions and/or trade the bounce for a 2-4% move. Unless we can establish a foundation for a sustainable move to the upside the sellers are still in control of the trend.

If you want to play a bounce off the lows, the best place to look is at the sector that have sold the most. Financials gained 1.6% in trading on Tuesday and they are the leading sector on the downside. Energy (XLE) and Basic Materials (XLB) are the others not far behind. Watch for them to offer the most from a bounce play. Semiconductors (SOXX) have been another big loser on the downside are in a position to bounce. It is important to note that a bounce in a downtrend is like selling in an uptrend, short term events that give opportunity to the prevailing trend. The saying buy on the dip for an uptrend, is short on the bounce for a downtrend. Thus, buying the bounce is a trade at best! In fact, more times than not, most of the bounce happens in the pre-market trading. If you play the bounce, do so with extreme discipline and understanding of the prevailing trend and risk.

There will be opportunities as the data supports a sustainable move to the upside to own stocks. Attempting to pick the bottom or the top of any trend is a dangerous game, but like being at the county fair, the lights and the excitement draw us into believing we can win. Maybe you will win, but the odds are not in your favor. Investing is all about risk management, and betting on a turn around based on the current data and technical indicators is just that… betting.