Saturday, August 9, 2008

Has the Bear Market found a Bottom ?

An excellent piece The fundamentals of market bottoms dicusses how market lows are made. A reading of the article is recommended. Here are the salient points:
The Investor Base Becomes Fundamentally-Driven
....But at the bottom, even long-term fundamental investors are questioning their sanity. investors with short time horizons have long since left the scene, and investor with intermediate time horizons are selling. In one sense investors with short time horizons tend to predominate at tops, and investors with long time horizons dominate at bottoms.
....The market pays a lot of attention to shorts, attributing to them powers far beyond the capital that they control.
....Long-term fundamental investors who have the freedom to go to cash begin deploying cash into equities, at least, those few that haven’t morphed into permabears.
Changes in Corporate Behavior
....Primary IPOs don’t get done, and what few that get done are only the highest quality.
....There are more earnings disappointments, and guidance goes lower for the future. The bottom is close when disappointments hit, and the stock barely reacts, as if the market were saying “So what else is new?”
(My notes: This has not yet happened in India. A minor decline in operating ratios saw the Reliance Comm stock fall 20%).
Other Indicators
....Implied volatility is high, as is actual volatility. Investors are pulling their hair, biting their tongues, and retreating from the market. The market gets scared easily, and it is not hard to make the market go up or down a lot.
David Merkel, who wrote this piece then makes a summary:
No Bottom Yet
There are some reasons for optimism in the present environment. Shorts are feared. Value investors are seeing more and more ideas that are intriguing. Credit-sensitive names have been hurt. The yield curve has a positive slope. Short interest is pretty high. But a bottom is not with us yet, for the following reasons:
Implied volatility is low.
Corporate defaults are not at crisis levels yet.
Housing prices still have further to fall.
Bear markets have duration, and this one has been pretty short so far.
Leverage hasn’t decreased much. In particular, the investment banks need to de-lever, including the synthetic leverage in their swap books.
The Fed is not adding liquidity to the system.
I don’t sense true panic among investors yet. Not enough neophytes have left the game.

My View:
Well, we should not argue with the Market. If the Market is moving higher, so be it. The two points that prevent me from saying 'bear market s over" are:
First, Not enough time has been spent on the downside. After a four and half year bull run, six months of a bear market are not eonough.
Second, Capitulation has not taken place. There are investors / Traders all over the place. Most participants continue to stay in the Market. Surely, a bear market does not end with cheer and joy.
Actionable Ideas:
All technical analysis MUST conclude with actionable ideas. So, here are my action plan:
1. Go with the intermediate trend. This trend is UP, so try to buy on dips / breakouts / consolidation.
2. Since there is uncertainty about the end or otherwise of the Bear Market, stay with blue chips. This means, while I will trade in stocks like Reliance & Tata Steel, I avoid RPL, RNRL, Ispat, Ansal, Parasvanath, ....... in fact, all of the so-called momentum stocks.
I should point out that much of my trading is Intra Day, mainly in Index Futures. This is done through mechanical trading strategies. The action plan outlined above refers to positions that I take mainly for swing trading.

1 comment:

anshul said...

thanks a lot is good post and iam completly agree with u in ignoring so-called stocks like rnrl and ispat in this kind of bear market rallies.. i want to request to u that u should write book on how to trade in markets..plzz write a book it would be more helpful to all...this blog is very helpfull but a book from ur side will sharp trading strategies of traders