Research & Advice

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What’s Next?

Wednesday, April 20, 2011

 

 

  • Since mid-February, the stock market has been involved with that sort of trendless action, as most of the major price indices have been moving within a relatively narrow trading range – essentially moving sideways, absent an uptrend or a downtrend.

  • There have been many periods of market stalemate throughout the years since 1933, but they have all been of short-term trend significance (think weeks, maybe a few months). Most stalemates have been resolved to the downside.

  • These types of stalemates historically have not led directly to major bear markets.

 

In regard to the market, the answer to the question “what’s next” depends upon your timeframe. What’s next in the short-term should make no difference to longer-term investors (theoretically speaking, that is – when invested, none of us are comfortable during periods of market declines).

It is simplistic, comfortable, to think about the movements of the stock market as being composed exclusively of just two basic elements. Uptrends and downtrends. True, if you want to be clinical about it, that black & white purview can be applied to past, pre-defined periods of time (the market is down today, it was up last year, etc.). Still, clinical purviews aside, when a third element emerges, like a period of no apparent trend, definitions can become confusing – and so can the art of predicting.

Since mid-February, the stock market has been involved with that sort of trendless action, as most of the major price indices have been moving within a relatively narrow trading range – essentially moving sideways, absent an uptrend or a downtrend. This stalemate has been the result of weak Demand (i.e. lackluster buying) accompanied by calm Supply (i.e. a tepid desire to sell). It is difficult for prices to advance across the broad market while investor Demand is stagnant, and it is equally difficult for stocks to decline when the desire to sell is diminishing (thus the current stalemate).

It is important to define markets. And it is important to identify the reasons behind a trendless market. But what is most important is answering the question of how long this stalemate between uninspired buyers and reluctant sellers is likely to last, and what are the risks this condition could devolve into a bear market, thus pushing stock prices sharply lower?

There have been many periods of stalemate throughout the years since 1933, but they have all been of short-term trend significance (think weeks, maybe a few months). A small percentage of such cases have been resolved to the upside, but not enough cases to be considered statistically relevant. Most stalemates have been resolved to the downside as nervous investors begin selling to reduce risk, obviously creating the downward Selling pressure on prices needed to complete a short-term correction and thus attract renewed buying enthusiasm at the lower stock prices.

Typically that attraction of renewed and enthusiastic buying occurs from the point of an oversold level. As stated in a prior report, Berkshire Money Management believes that the damage to the tape has largely been defined by the mid-March lows (about 1,250-points on the S&P 500). That represents less than a four percent drop of the market from the current “as I write” levels. In other words, any further market decline to oversold levels is likely to be relatively mild.

It is worth repeating, these types of stalemates historically have not led directly to major bear markets. Bear markets occur because the desire to sell stocks swamps the desire to buy. There has thus far been no evidence of that. Could that change? Sure. But virtually all major market tops have been preceded by extended periods of increasing selectivity, as reflected by four-to-six months of negative divergences as stock indices continue to head higher while, at the same time, advance-decline lines diminish (in other words, fewer and fewer stock support market index levels). Advance-decline lines were making new highs as recently as April 6th, still allowing for market indices to be led higher.

Bottom Line: Periods of stock market stalemate are frustrating, but they are typically of minor significance to longer-term investors. A bull market appears to still be the primary trend, with months of further gains ahead. Thus, the periods of short term market weakness that are expected for the weeks (month?) ahead should continue to be viewed as opportunities to cull weak positions from portfolios and add strength with the resulting proceeds.