[Editor’s note: The following article originally appeared on April 15 on the blog Futronomics, hosted by Matt Stiles.]
"The greatest trick the Devil ever pulled was convincing the world he didn't exist." -- Keyser Soze
The job of a bear market rally is to convince as many people as possible that the bear is over. The more pessimistic speculators are in the preceding plunge, the more violent the subsequent rally must be to change their minds.
This holds true for individual stocks, sectors and entire indices. The same goes for corrections in a bull market. It took a massive crash like that of '87 to convince enough people that the bull market was over - immediately before embarking on a 12 year mania.
I've covered where I think this rally will go and how long it will last in my technical updates. But as it progresses, my eyes will shift away from potential long candidates (as I showed back on Mar 3 with "On Bottom Fishing") and toward short opportunities.
In doing so, I will be employing a similar tactic of looking for certain sectors or individual companies that have not participated much in this rally. There are some differences in the method, however. When looking for potential candidates for a bear market rally one should look at the unwillingness of a certain stock or sector to surpass previous lows while broad indices have done so. Or one can look at the total decline from the peak price. But when looking for candidates to lead the next leg of the bear market, I will be looking at the percentage recovery between the peak price and the lows.
In other words, just because financials may have doubled over the last 5 weeks, the recovery is quite mild in comparison to its peak price. The chart below highlights a number of different indices and sectors along with their percentage recovery from peak prices.
(Note: peak prices for the various indices occurred at different times. Homebuilders peaked in '05. I used '07 peak prices for the Nikkei and Nasdaq - not their absolute peaks many years before)
When used in combination with other indicators, the relative weak recoveries of those on the bottom of this list could be a signal for underperformance during the next leg down. I stress "in combination with..." because any indicator used on its own is useless. I would also take note of whether or not the security has passed its early January peak or not, divergence late in the rally, volume and a number of other factors.
As such, my eyes are focused on the utilities, financials, health care and energy producers. I could have also added crude oil and copper to the list above. However, beware that just because these commodities have traded in tandem with the overall economy and markets for quite a while, they won't always do so. Correlations between asset classes often break down as soon as the average person believes they are gospel.
Keep in mind that I do believe this rally has much further to go and will likely be interrupted by a very convincing correction somewhere along the way. How these sectors and the others perform during that correction and the subsequent rally to new YTD highs will be of great interest to me in determining what I will be shorting. As will be the individual sector reactions to earnings reports. Keep your eyes and ears open for bottom callers and steadily rising sentiment indicators. I don't think the coming top will be marked with token analyst bullishness. It will be "common knowledge" that the worst has passed and "happy days" are here again.
I would also note that the next leg down will be characteristically different from the first. I fully expect to see many names go to zero and others to stay relatively buoyant (although relative strength to zero isn't difficult). The retail space specifically has an enormous dichotomy. Some companies like Best Buy (NYSE: BBY, Stock Forum) and Wal-Mart (NYSE: WMT, Stock Forum) have hardly budged while others like ones that rhyme with "Lacy's" and "Mannequin Hands" are looking atrocious. Just because the retail sector has been doing very well of late does not mean there are not opportunities. You have to dig deep to find the weak ones. For legal reasons I won't be doing much of that here (too many bloggers have been served with "anti-defamation" suits for suggesting specific shorts - ludicrous, I know. Apparently free speech is no more).
Is there anything that my readers have their eyes on? Am I missing something in the list above? Can I finish this post without slipping in a little "Go Canucks Go!" nugget?
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This article was written by a member of the Stockhouse community.
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To read more work by Matt Stiles, visit the blog Futronomics.