Chaos breeds opportunity

I detest making 'predictions' -- in particular, re the general market averages and their price oscillations. The fact is, as JP Morgan noted so many decades ago, "It (the market) will fluctuate." These fluctuations create our opportunities to buy and sell. My post, Battening down the hatches, which is more of a recognition of increasing risk and the need to monitor positions more closely, inspired a flurry of mail. First, a private message...

I think you've done a very good job of summarizing the potential state of play. I don't pretend to have any idea how things will play out, but your analysis is cogent and inciteful (sic). It is always a worry when leaders start acting badly. (For example, I was just looking at GOOG. This is nothing but an instinct, but for some reason it looks like a set-up for an island reversal. I don't follow it like you do, and I really have no particular opionions, but it just looks that way to me. My opinions on this subject are worth what you pay for them, if not less.)

And it's a big worry when all the market strategists are as unanimously bullish as they now are. However, I have also been observing the divergence between the way that this year's big winners (aka leaders) have been acting of late, versus the way some of the laggards have been acting. I have a gut feeling that there is a lot of year-end profit taking going on with managers who want to lock-in their year ('s return). Hence, the selling of winners and the accumulation of the beaten-down. I would not be surprised to see that pattern reverse after the first of the year. However, you are quite right: Prudence certainly dictates caution for those whose time horizons are not truly Long Term.

Well stated; I agree with your insights. I, too, note the emerging up trend in what typically is called large cap value stocks. The small cap growth stocks I prefer slowly and incrementally begin to under-perform both relatively (to the large caps) and absolutely (to themselves). So my warning, if you prefer to view it as such, is as much to scan for new opportunities in areas not typically explored by me. Large cap stocks fail to excite me because we all know their names, their products; as a class, they tend to be over-followed, over-researched, and over-owned. None of which argues profits cannot be had in this market sector.

So the market always rotates; from sector to sector, group to group, even within a group. A market decline need not beget a bear market akin to the one most recent (2000-2002); a typical bull market correction, however, still could see prices decline 30-50% from the highs and with many, many months elapsing before each stock re-emerges on the right side (up side) of the chart.

Is this truly an island reversal in Google/GOOG shares? Perhaps, but how predictive will it prove to be? At worst, arguably, Google/GOOG could decline toward ~$425 (~10% lower from here) before basing anew. This is what long term winners do; lead higher the general markets, correct, base, and then lead again. Certainly, I see nothing on the horizon that smacks of fundamental concern. (Well, there is a blossoming matter of corporate hubris that takes root; I hope reader, Ray Seakan, shares more of his experiences in this regard.)

So my argument is the same as always, MIM. For those new to that term (and this site), it is an acronym that stands for, money in motion. And what is wong with that? (The process, not the acronym!) Alas, I have the intestinal fortitude sufficient to hold for the epochal advances, less so for the epochal declines. So I buy and sell, moving to and fro, hither and yon. I will always be wrong in some fashion or manner or decision irrespective of my time frame. I no longer rage against the (market) machine in the attempt to be right; I accept my foibles, lackings, and failings for what they are and attempt to manage around them. I accept that reality with as much grace as I can muster. But all that is me; it need not be you, or anyone.

Greg Reiman comments publicly in response to the post in question...

[I] am trying to make money in a very short term time frame on this trade. LVLT could indeed be a long term winner, in fact I hope it is. But the short term trend looks down to me. I did consider the top 8 months prior but didn't think it fit the trendline properly.If I draw an ascending triangle, it has already violated that pattern to the down side. If it only declines to it's 50 day moving average soon enough I should make 100-300% profit on my options, if it trades down to the $5 support level with some time value left, I make even more, if it trades down to it's 200 day moving average I make 500% or better profit on the options. It fits my risk/reward goals.

That all sounds good to me, although I must admit you include many "if" statements in your thesis. Interestingly, the Wall Street Journal reports today that there are reasons to be wary of Level 3 Communications/LVLT.

The co remains saddled with debt, it is in a business that still has excess capacity, and it has reported a quarterly profit just once in its more than 20-year history. With the stock and bonds at lofty levels, it could be that any future possible good news already is priced in. Even bullish analysts acknowledge that to keep the stock climbing, demand for video and voice over the Internet will have to be strong enough to allow Level 3 to increase what it charges big telecommunications, cable and other businesses for access to its fiber network, one of the world's largest. Level 3 also will have to demonstrate that it can skillfully integrate a series of recent acquisitions. The co will also have to show that it is getting closer to pulling more cash out of its business than it is putting in. By one measure, Level 3 stock and bonds are a bit pricey. Its enterprise value is about 13 times the co's Ebitda for 2009. And prices for access to networks have fallen about 15% this year. While much slower than the 50% rate of 2004, that still is a troubling sign in a market where demand for network capacity has increased at a rate of about 60% a year in the past two years. The capacity glut is so huge that it could take years before it is filled up.

Okay, so much for the bear's thesis. But we already know all this stuff. Sheesh. Instead of derogating a stock that likely builds a massive, long term bottom, look for the reasons why the market slowly but surely turns increasingly bullish. Reiterating yesterday's news will not help that effort.

But back to the stock and your trading thesis. I differ with you in strategy. I prefer -- nay, I insist -- that the stocks I purchase long must be market leaders. (A topic I have oft discussed here.) If I seek to short a stock, then I insist it be a weak stock in a weak group with terrible fundamentals. (Of course, it becomes a horse of a different color if we differ as to whether LVLT in fact builds a long term bottom.) Investing with such a strategy brings you around to have the wind at your back, not in your face.

Terry Griffin's comments offer fodder for thought...

I don't know why, maybe a psychological flaw, but my adrenaline always races when I see a post like this from you. Chaos begets opportunity?

Yes, absolutely correct. Investing never has been nor will it ever be a one-way street. Risk is the yang to the yin of reward. Accept each, embrace each, and factor into your analyses the continuum and you will see... truth. (Whew, did I really write that?) No longer will you invest with your eye cast backwards to what the stock has done, but forward to what it has yet to do.

Consider Under Armour/UA. From a new all time high at $54, it reversed and traded down to $48.75 (very near the $48 support I limned in advance) before reversing up. Which all means the stock traces out something of an area pattern between $48 and $54. With that knowledge, an investor could (would, in my case) buy the declines to ~$48 and sell the rallies to $54. And then will come the moment of clarity; a moment not far away, if I am correct.

During any decline, watch price action, volume, and relative strength (as caculated by Daily Graphs) for emerging leaders. Use the Daily Graphs sector analysis to find groups and sectors on the move. This is one of the best tools out there, bar none.

Money in motion, and all within the continuum. Yeah, that's the ticket.
-- David M Gordon / The Deipnosophist