September 18th, 2008

Will Today’s Volatility Prove Constructive

Just yesterday I wrote that the S&P 500 Index:

“was about to connect with the bottom boundary trendline of a downward sloping wedge that goes back to the October highs…Will it bounce on the support of the bottom boundary trendline of the descending channel or will it break through that trendline and seek support elsewhere?”

It didn’t take long to find out; we got the answer today. As I write this, news just came out that Sec. Treasury Paulson is discussing reconstituting the Resolution Trust Corp. or some other sort of government-initiated entity to help absorb, rehabilitate and resell all that toxic debt. As a result of that news, most of yesterday’s major decline was reversed. Many of the “professionals” are now talking about “all the cash sitting on the sidelines waiting to jump back in”. And CNBC describes today as an “explosive market, the biggest increase since March” but not as merely recovering yesterday’s “biggest one-day decline since 9/11”.

What are we looking at: a fallin’ or fallen knife? Is this the turnaround, the bottom everyone’s been waiting and hoping for? To be blunt, in one word, no. In short, it’s going to take more than one day to make a bottom. In my July 16 post, when the market tacked on 2.51%, I included the following table:

So today’s move, in fact, was the largest since the Bear Market began. After the March 18 move, the market added another 7.21% to May 19 and then resumed its slide. After yesterday’s decline, the market had dropped 9.34% from that 1330.74 March 18 close. What makes this market so treacherous is that over the 45 trading days since that July 16 close (a day labeled by some as a follow-through day) there have been 12 over 1.5% up-days, 12 over 1.5% down-days and only 21, or less than half, were the change was less than 1.5%.

Today, the market actually moved 6.8% from low to high. Volatility like this might be great for some but it’s no place for the typical individual investor. We want momentum not a whirpool of swirling water … lots of circular action but no directional movement.

At times like this we have to stick to our discipline and continue on the sidelines waiting for confirmation of upward momentum. Perhaps the new “Resolution Trust” will become reality and will, in fact, actually calm and turn the markets. But that’s going to take a while. As I wrote on Tuesday,

“that’s why we have an emotion regulator, the MTI (Market Timing Indicator). We need to meet certain criteria before we have sufficient confidence to return to the market and that hurdle is an S%P 500 increase to approximately 1335.”

I was planning to write about a strategy for beginning to assemble a momentum-driven portfolio for when upward market momentum returns but, again, discussion of the market trumped any discussion of individual stock selection. Perhaps tomorrow.

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