The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

09 June 2006

Well, how about THAT?

Yesterday's rally, although expected (see post below), was nonetheless impressive.

All the market averages succumbed early-on to exaggerated weakness; it was a give-away. The rally from the intra-day lows came on a good increase in volume; always desired. Apart from the price swings is there any discernible change in the backdrop? Yes, and the most obvious of those is a slight turn up and for the better in the US$; I believe this strength is crucial for positive market conditions in this environment. The price swing does not have far to traverse, however, before it encounters significant resistance (~86.5-87).

Despite the swing up, the charts of the market averages still have an ominous cast: simple peak & trough analysis finds a discernible pattern of lower highs and lower lows. A quick & dirty time count could be appropriate here, so let's use the 2½ unit rule: this rally must sustain itself for in excess of the next 2½ days to factor as meaningful. I suspect that between now and Tuesday's close the market will again turn down. (The reversal could occur as early as this afternoon.) The question then would become, "Will yesterday's lows hold?" On a price level basis, the SnP 500/SPX could rally ~10 points more from yesterday's close (to ~1270) before encountering resistance. This all might seem confusing at first blush, so allow me to state it differently: the strength of any trend is not the one obvious to all but its tests of the trend and the tests of those tests. That is, if yesterday's low represents the low of the decline, then a bottoming process must ensue from that point, which denotes additional declines to the lows that hold at what is now support.

Still confusing? Consider this: during a market sell-off akin to what has transpired over the past 5-6 weeks, the professional trader scans first for two type of patterns -- those that have sold off the most (horrific price declines) and those that have sold off the least (held up well on both an absolute and relative basis.) Several charts might show this better...


Apple Computer/AAPL...


(charts and additional commentary to follow; no uploading capability all morning -- dmg)
But all this chart analysis is meaningless when it comes to money (portfolio) management; different principles rule there than making silly predictions. For example, Trader Dan phoned me yesterday. He wanted my read of the chart of Johnson Controls/JCI. It seems he has a client who inherited the position, and has now owned it for years. All I could say was, "Wow, bully for him!" But should he (the client) write covered call options? Did I think the stock had exhausted its primary uptrend that has endured for several years? Those are not the questions to be asked, as *I* perceive the issue. Yes, the shares might have peaked, but in what time frame? He (the client) has managed to hold the shares through all the other seemingly (at the time) disastrous reversals. In fact, the market now pays him to diversify -- to create his own diversified portfolio using JCI as a source of funds. For example, for each 100 shares of JCI he sells, he could purchase 1,250 shares of Ford/F. Now we all know about the problems Ford struggles to get past -- they make for a compelling case to avoid the stock -- but still I could build a bullish argument. However, that is not my purpose here; now I merely point out that the two stocks are literally (and very obviously) the mirror image of the other. If you believe that stocks ultimately regress to the mean, then selling one and purchasing the other in a ratio of 12.5:1 qualifies not only as sound portfolio management but creates the investor's own hedge fund -- with the hedge being diversification. Yes, Ford/F might go belly-up, but F would not be the sole new purchase, of course. (BTW, if you do not like Ford/F, there exist many other stocks whose charts are the mirror image of JCI's.)

Finding investment opportunities come in many guises, and make investing fun.
-- David M Gordon / The Deipnosophist

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