Top Line: The stock market is in the early stages of the rally we have been waiting for the last two weeks...yes, finally. We expect a rally that will come as quite a surprise to most analysts or, for that matter, amateur traders like us.
In the last couple of days we have heard some comments and questions from a few sources. We thought this would be a good time to answer these questions. We're trying to let the market tell us what to do and the questions are all about whether to trade your cash in for stocks or keep the stocks you have.
How low can the Dow drop this year? We don't really think there is much reason to talk about what may occur in December because that's not what anyone cares about. What we all care about is Now. Let's be clear, we are generally bullish for the next several months with a few scary drops during that period. But, just for argument, we will consider a short term drop for discussion.
Elliott wave theory may need to be employed at this stage. There is a minor chance that the current downturn is a wave five like we mentioned in yesterday's post. If this is true, we can sort of estimate an area where the "low" may occur.
[Tutorial: For Elliott wave, the first wave and the fifth wave can have a similar length. You may remember that the first wave, the third wave, and the fifth wave travel in the direction of the main trend while the two wave and the four wave are countertrend waves and move in the opposite direction of the main trend.]
So, how long Is wave one? Well, the high was back in October of 2007, and the first wave down was about 2500 points from 14K down to 11,500. This would imply that the fifth wave could be 2500 points also. Now, when did wave five start? That's a big question for the Elliott wave stance. Some may say that it has not started just yet but if it has, we could argue that the start of wave five was around 9500 or a little higher than that. That means that A target for the end of the fifth wave would be around 7000.
We could argue that the November low right around 7400 Could be the fifth wave low and we are now in the countertrend move to correct those five waves down from the 14K top. Here's where Elliott wave can help us again. Those five waves down we have been talking about are the essence of Wave One of the big down move that we expect to last for a long time. The important thing to know is that the countertrend usually has a minimum target of 38.2% and a maximum target of 61.8%. Those would be about 2500 and 4000 points off the low. Just an estimate as to targets for the Dow would be a range of about 10K to 11.5K based on these numbers. These are approximate numbers and just give us an idea where we could go. The one issue here is that a wave two is notorious in that it likes to go much further than 61.8%. This excess movement is driven by people who will think the worst is behind us and it's off to the races again.
Our position is that the market has seen the lows but there could be slightly lower 2009 lows. We don't think it's enough to stop you from buying. Over the past week, we have moved out of cash and into the market. We had sold some of our positions in late December to prepare to short into the strength we would have by the inauguration...well, no that didn't happen but with that cash we got a nice present from the stock market in the past few trading sessions when the Dow dropped below 8000. We bought a couple of stocks that are near their lows of the last couple of years. Plus, the leftover cash we had in our 401(k) was moved into the market on Tuesday. We have very little cash left, maybe about 3% of total assets. We are fully long and bullish in case you are wondering.
Today's market was just what the doctor ordered based on that VXO high we saw in Tuesday's trading, not to mention that drop below 8000 again. These prices are hard to ignore and represent good entry points for this Bear Market rally.
During the day, Jamie Dimon of JPMorgan decided his company was cheap enough and bought 500,000 shares, an $11 million purchase. This is a guy who is not going to get a bonus this year and he had to pull this out of his saving's account in order to buy these shares. Ok, maybe that's not what he did. Also, Ken Lewis over at Bank of America bought some stock. So, if you think the bank stocks are going to zero, Why are these guys buying their own stock? To us, this is the one thing that should make Everyone realize that the financials may have found a bottom...
The Treasury bonds spent the day dropping over 3%. When these T-bonds go down, we get more bullish on the stock market because a lot of this money being taken out of bonds will go into the stock market. Even the dollar reversed course on Wednesday.
Also, after the market closed, AAPL brought us a little bullish present just like IBM did on Tuesday evening. AAPL's earnings were better than expected giving the market another excuse to go up. This evening the US futures are up strongly with a nice pop scheduled for the opening bell. Asia is trading up about a percent. Since Europe was down on Tuesday, they have some catching up to do so there should be a "spin around the globe" rally...at least at the US open...no, not the golf open, the Stock open.