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!

28 November 2008

Throw a dart

Focus solely on price, and miss the big picture.

But if you prefer to focus on price, remember what I said in my
Kairos post,
"... note those stocks that build internal bases and improve on a technical basis within the confines of their overall negative trend. For example ... several key large cap companies, but especially the pharmaceuticals, have produced important long-term relative strength changes in recent weeks ... Other stocks in other groups and sectors of the market behave even better."

Note well the preponderance of capitulative lows made on 10 October; iow, right on schedule. Also in the Kairos post was this comment:
"Consider that the first group of stocks to emerge could be those traditionally favored by institutional investors; specifically, large cap." (Go back and re-read the remainder of that paragraph for added insight.)

Martin Sosnoff, of Atalanta Sosnoff Capital, provides an excellent example of a time-tested institutional investor; Marty has invested successfully through all phases of the market's cycle. All investors should read his recent Forbes article (a snippet of which is below)...

On Black Monday in 1987, I remember a conversation with Mike Milken. We were talking about where the money would come from to shore up the market. Milken said, "I can identify at least 500 individual money pools with $500 million available for the market. The money's in the country." I feel the same way today. Kirk Kerkorian is a good example, but he was early and chose the wrong stocks, first General Motors and then Ford. Kerkorian got burnt fingers trying to relive his felicitous experience with Chrysler decades ago. There are dozens upon dozens of billionaires waiting to step into his shoes and become players. Just you wait and see. Good riddance to October. During October, daily fluctuations of 5% to 10% prevailed. Specific sectors like the financials showed weekly ranges of 30% and much higher even among sizable properties like Goldman Sachs, MetLife, Bank of America and Morgan Stanley. An efficient market, anybody? ... forced liquidation was a factor in the market's demise but that the worst may be over sooner rather than later. So take your head out of the oven. The market may sell as low as 10 times earnings for a while but when inflation is low and 10-year Treasuries yield approximately 4%, the market normally sells at a mid-teens price-earnings valuation. I'll take the other side. Obama comes out running his first 100 days in office, pushing through a $300 billion stimulus package. It contains enough infrastructure spending to shorten the recession by a couple of quarters. The market smells blood and begins to discount the next recovery by at least six months. Last week, it felt as if this scenario was beginning to be tested as investors seemed to begin to value stocks not on recession earnings, but rather on normalized earning power over the next recovery cycle. I'm seeing too many major companies with positions on the board selling today at 10 times earning power or less. Leave aside most banks and brokers as too difficult to model with much confidence. My list is long: It includes...

Marty then proceeds to name the stocks of many companies, each large cap. Understand yet...? Non-institutional stocks tend to be bull market phenomenons -- they rise almost exclusively during a bull market; i.e., the last to rise and the first to decline. As such, they primarily are the domain of retail investors... the very same investors who likely are frightened away from the markets for a long while to come. Meanwhile, institutional type stocks will rise and rise and rise some more -- yes, to new all time highs -- because
1) Professional investors invest throughout the complete market cycle;
2) They purchase stocks with sufficient liquidity to sop up the massive sums of monies at their disposal;
3) Their mandate typically forbids purchases of stocks that sell for under ~$15/share;
4) Etc.

Returning to the Kairos post, I also said
"Subsequent to the low trade, comes the bottom, which self-defines as a lot of give and take, price movement up and down but confined to a range, an area pattern. Time heals all wounds. Whether a bottom builds from recent lows, or later from even lower lows, certain items must transpire before a more bullish price environment (read, continually rising prices) were to appear. Viewed on a chart, these certain items include (but are not limited to):
a) A diminution in the total number of stocks that trade at new lows (recent numbers have been astronomically high);
b) The decline's trajectory loses its nose-dive formation in favor a flattish shape;
c) Hold repeatedly at support;
d) An upside reversal off said support;
e) A subsequent test of the upside reversal;
f) A breakout above initial resistance;
g) A breakout above its 50 day sma;
h) A price rise toward its 200 day sma;
i) A retracement back down toward its 50 day sma;
j) Back and forth price action circumscribed by the two moving averages;
k) A breakout above its 200 day sma;
l) A new right side to the chart builds.
Among the many price tests and re-tests comes the crucial news response syndrome. Stocks fail to make lower lows, even as the economic and financial news worsens..."

Now is a good time to show you how the above steps work real time via annotated charts. First condition "a" is being met now, as new 52 week lows contract severely and very quickly and the new 52 week highs begins to expand. 52 week highs in this market environment? This is a little noticed but very positive change. All the other conditions, can and should be seen visually, which I will do below, beginning with the news response syndrome.

[click on each chart to enlarge]

Deere/DE reported earnings before the markets opened Wednesday that were worse than the market expected; in reaction, sellers sold and the stock tanked on the opening. But in a 'surprise' development, the stock reversed and closed substantially higher. (See chart above.) This reaction, the news response syndrome, and the building positives within DE's internal pattern augurs for follow-on gains.

You can view more of the initial steps of a reversal and bottom in the chart above; each letter corresponds to the steps quoted from my Kairos post (higher up on this post). Again, the capitulative low on 10 October (highlighted but not pointed to) stands out like a sore thumb; while investors fret and predict even worse price declines to come, stocks quietly go about their business. The worst of the decline occurred, as stated, during the one week of 3 to 10 October -- and then it was all over but the shouting.

More of the steps of another institutional stock that also hit its capitulative low on 10 October, and builds one bullish development after another. Note, too, how compressed the decline is on both the x and y axis. All the sound and fury for this... blip? This price decline (amplitude) is barely noticeable, leave alone notable, and the amount of elapsed time (from high to high, or magnitude) is brief enough to raise barely a squawk. Or hurt.

And last -- but certainly not least! -- is the stock shown in the chart above. Note that its capitulative low was the earlier 15 July (recall Don Coxe's brilliant scenario as mentioned in -- where else but? -- my Kairos post), with a second, and higher, test on 10 October. Easily observable to all viewers by now is the increasingly obvious and bullish pattern of higher lows and higher highs. Do you recall this comment (also from my Kairos post)...?
"... note those stocks that build internal bases and improve on a technical basis within the confines of their overall negative trend..."

Look again at the chart immediately above, but look closer this time; really see it. You will see variants of this pattern begin to proliferate... before it finally comes to predominate. My Kairos post, and other posts before it, could not prepare you any better for what transpires now: a changing reality... a change in direction.

An investor could purchase (trade) at any of the steps I limned in the Kairos post, and be successful. All while the news backdrop worsens, as it will, and as the markets bounce about; rally, test, rally, test. By the time most investors finally make the decision to shed their overwhelming bearishness, the early leaders -- the 2 or 3 I share in this post, and many, many others -- will be higher in price, substantially higher. So study the market averages for the markets' direction and trajectory, and base your investment decisions on your perceptions thereof, if you prefer, but recognize that the markets rarely, if ever, proceed monolithically down... or up.

The best investment opportunities occur at the oddest of times, such as now; consider that the charts I share above show stocks that change direction (to up from down), and not the many stocks that rise already to new all time highs. Surprise, surprise. Prices and values have been mercilessly and indiscriminately beaten down today, such that you could throw a dart and select a winner -- but only if you limit your dartboard of possible investment opportunities to large cap stocks with strong technical patterns and studies. Define your opportunity, your core competency, for success.

Please do not scoff at the notion of investing in large cap stocks...
1) They typically begin major market rallies;
2) They represent the leading edge investment opportunities; merely the first step, the first class and type of opportunity of many classes and types of winning long-side opportunities yet to come;
3) If your investing objective is to make money (and do not laugh, it is not everybody's), then you have everything on the institutions for investment success, especially nimbleness. Buy the same stocks they too will buy, but do not yet know; their buying will power higher the shares you purchased in advance, and will sell to them... at higher prices.

Invest well.

Full Disclosure: Long the shares of Deere/DE. (And the other stocks in this post whose names I do not reveal.)
-- David M Gordon / The Deipnosophist

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