March 21st, 2008

As the Market Bottoms, Toll Bros. (TOL)?

This week has been so confusing, depressing, distressing … like a roller coaster ride. And there are so many conflicting comments. While many say that nothing new has happened others, like IBD, called yesterday a follow through day and changed the Current Outlook from their Big Picture column to “Market in confirmed rally”. According to IBD:

“You’ll want to see up days in higher volume for the broad market indexes.

Just as importantly, you’re looking for strength from leading stocks. During the height of the recent correction, only a few stocks set up in proper price bases and fewer still managed to break out.

For now, don’t rush in too aggressively. Let the market prove itself first. If you see that improvement and want to buy a stock or two, start by buying half as many shares as you plan and add as the stock proves itself.”

I respect IBD immensely, especially the invaluable data they provide on industry groups, but I think this switch to “confirmed rally” may be premature. According to the charts and my MTI (Market Timing Indicator, a momentum-type indicator; a descriptive pdf file is available at your request), the market is still in “all cash” mode and the S&P 500 hasn’t yet even crossed back over the 300-day moving average:

The Index may successfully complete that cross over and may have sufficient strength to cross over the 180-day moving average (or an Index of approximately 1395) but, even then, it will be a reading of 12963 (or 3 Index position x 4321 MA rankings). On March 10, in a post entitled “Next Way Station on the Road to 1150 on S&P 500”, I wrote:

“The Index is significantly below all the moving averages making up my momentum indicator, each of which is also falling precipitously. A bounce at around 1233-1250 will also serve as an opportunity for those who’ve been waiting for it also to seize the opportunity of “selling into strength”. Strictly from a technical perspective, I can envision several possibilities extrapolated from here:

  1. the index stalls momentarily before resuming its descent without crossing back over any of the moving averages and the moving averages retain their alignment
  2. as the index stabilizes it crosses back over the 60-day moving average
  3. as the index stabilizes it crosses back over the 60-day and 90-day moving averages
  4. as the index stabilizes, the 60-day moving average to cross back over the 90-day moving average
  5. as the index stabilizes, the 180-day moving average rises and crosses back up over the 300-day moving average.”

The rate at which the moving averages are declining (brought about by the step decline in the Index itself since October) creates the distinct possibility of the 3rd alternative above occurring. That has happened 42 times over the past 44 years and in 11 of those occurrences, or almost 25% of the time, the MTI has followed through with an “all in” signal. In 75% of the cases, however, the market has played the part of a “recidivist” and retreated back below the moving averages and then continue its downward momentum.

So, in my opinion, the market is still signaling too much risk to begin buying aggressively. Having said that, last Saturday, I wrote that the Homebuilders Industry Group appeared surprisingly to be moving up in ranking and therefore a fertile area for the new market leaders. The Group was ranked is ranked 7th this week. Stocks in the group have held up relatively well since the middle of last year as the credit crises blossomed (true, these stocks are down 50-70% from their all-time highs). Toll Bros. (TOL) chart, a past Industry leader, demonstrates how the stocks performance has recently out-performed the averages and is forming a potential bottom:

A word of caution is necessary here. I learned long ago that stocks that have fallen substantially or are less than $20 often form patterns that appear to be bases or bottoms. How could they not? Where else can the stock go other than to zero? So what at first blush appears like a base or bottom is often merely nothing more than a stop on the way to oblivion.

And if the stock successful survives and revives, there’s much headwind from all those investors who continue to hold on while looking for opportunities to catch a bounce to bail out. It could take years for the stock to fully turnover and wind up in new hands so that holders can start showing profits as the stock starts moving up.

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