November 3rd, 2008

A Strategic Dilemma

“The average stock in the S&P 100 (which represents the largest cap stocks in the US) is 13.8% below its 50-day moving average. ” That’s the lead sentence to an interesting table prepared by Bespoke Investment Group. The reason I point this out (it’s not something I do that often), is to underscore the challenge the market has before it can begin to thoroughly heal itself and begin a sustainable Bull Market move.

The stocks in this list have be devasted so badly that it will take a long time (no less than first quarter next year) before they cross above that moving average, let alone cross above the slower moving 90-day moving average, the minimum to become a “golden cross” stock.

That presents an interesting strategic dilemma: 1) buy these large cap stocks in the hopes they will recover and move above the 50-day moving average to capture the average 13.8% gain or 2) buy smaller cap stocks that have already crossed above their moving averages. Interesting … and I’m not sure I know the answer. But I’m sticking with what appears to be the statistically correct answer. The stocks that recovered first and lead the way out of the 2000-2003 Tech Bubble Crash (had the largest gains during the first six months after the absolute bottom was reached) were stocks that had made “golden crosses”.

Having said this, the backdrop is a question of the overall market. One of the beautiful aspects of computerized charting (as contrasted with the pencil and paper approach that I cut my teeth on) is the ease of deleting trendlines that don’t work and insert new ones that make more sense.

In earlier charts, those long-term trendlines were downward sloping. I’ve now corrected them to be upward sloping from the trendline combining the two peaks to combining what we all hope will be the two low points. Those two lower trendlines are the boundaries between which I believe the market is currently constrained (note: the trendlines emanate out of one and connect several forward theoretical pivot points, the areas where there was a significant change in the balance between supply and demand of stock that causes the market to change direction).

Given that we may be constrained between two trendlines, I’m compelled to replace a number of the stocks in the Model Portfolio with cash.

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