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Aug. 16, 2011, 12:01 a.m. EDT
By Kevin Marder
LOS ANGELES (MarketWatch) "” Stocks are acting as they should following the third-steepest nine-day descent in at least the last 49 years.
A bounce is to be expected following such a move and a bounce is what the market has delivered. The bounce says zero about whether or not the Aug. 9 intraday lows in the averages will be taken out.
By definition, a trend-following strategy such as the one followed by this column follows a trend. In other words, predicting/guessing when a new trend will begin is not part of the modus operandi. Waiting for a trend to be in place is.
S&P 500 by the minute over past 10 days.
Aiming for the meat of an intermediate-term advance is the target. Ignoring the first few days or, depending upon the extent of the prior decline, the first few weeks, off of a low may be considered a form of insurance policy. The policy protects against entering the market too soon. The premium, or cost of the policy, is the cost of missing out on an entry on the first day up in the averages, should the move blossom into a legitimate advance over the next months.
Following a decline of at least 8%-12% in the averages, it is instructive to assess the breadth, volume, and leadership of the subsequent advance.
Volume, a measure of demand for stock amid rising quotations, dimmed Monday for the fifth day in a row. Instead of being interpreted as a negative, this should be taken as normal for a market that just went through one of the greatest selling climaxes of the modern era. Seeing increased volume come into the market on up days in price will be a sign that large investors are re-engaging this market.
Based upon the below chart, the breadth of the market, i.e. the behavior of the average stock, improves with the averages. The chart shows that whereas only 7% of NYSE issues were in long-term uptrends two days before the low close in the Dow Industrials /quotes/zigman/627449/delayed DJIA +1.90% (above their 200-day moving average), twice as many names (14%) were in long-term uptrends two days later when the barometer printed its low close.
Leadership for the first two days of this advance resided in defensive shares. These have continued to rise, but have lagged the averages for three days in a row.
What this column is most interested in when it comes to leadership, however, is growth stock leadership. This can be categorized into two groups: the liquid glamour stocks, such as Apple /quotes/zigman/68270/quotes/nls/aapl AAPL +1.70% , Bidu /quotes/zigman/97715/quotes/nls/bidu BIDU -3.67% , and Amazon.com /quotes/zigman/63011/quotes/nls/amzn AMZN +0.32% , among others; and also the speculative glamours. The latter are younger companies that are in an emerging growth phase compared with the institutionally-dominated liquid glamours. The speculative glamours are going to see their membership ranks change from one cycle to the next, as some newer names emerge as leaders, while others fall by the wayside.
Monitoring the behavior of growth stocks provides two benefits. One is a window into the market's speculative sentiment, which facilitates general market analysis. The second benefit is that leading growth stocks provide superb vehicles with which an aggressive speculator can play the game.
We have many times discussed the "broken eggs and tennis balls" concept. After an intermediate-term 8%-12% correction in quotations, or greater, the names that act like tennis balls in their ability to bounce right back to new price highs are normally the leaders on the ensuing advance. The ones that sit there barely able to move off their price lows, the ones that act like broken eggs, are generally not going to be the dynamic leaders on the next advance.
It is to be noted, however, that simply buying the first merchandise that moves into new-high ground is not necessarily the optimal choice. Many times the stocks doing this have a V-shaped pattern to their price charts, which usually does not allow for a healthy cleanout of the bulls, which is the very purpose of a correction.
Lululemon Athletica /quotes/zigman/39660/quotes/nls/lulu LULU +0.72% is one such example of a stock with a V-shaped price pattern.
The better actors in the growth segment include Hansen Natural /quotes/zigman/52939/quotes/nls/hans HANS +0.21% , Apple, and Green Mountain Coffee Roasters /quotes/zigman/54683/quotes/nls/gmcr GMCR -1.16% . But it is not a time to be buying anything if one's investment program is oriented around the medium-term trend (several weeks to several months).
In addition to breadth, volume, and leadership, there should be a test of the initial low. As mentioned last week, this should see price revisit the vicinity of the initial low (Aug. 9) on less volume and fewer 52-week lows than the prior low.
In summation, a sold-out market stages a to-be-expected bounce on dwindling volume. Most growth stocks do not show leadership credentials, and are in need of technical repair. Large investors need to show they are ready to return to the feeding trough in size before an effective speculation campaign can be initiated. Until then, cash remains king.
Charts created using TradeStation. ©TradeStation Technologies, 2001-2011. All rights reserved.
All mutual fund ownership and earnings estimate data provided by Thomson Reuters.
At the time of this writing, of the stocks mentioned in this report, Kevin Marder or an affiliate thereof held no positions, though positions are subject to change at any time and without notice.
Kevin Marder, a co-founder of MarketWatch.com, is principal of Marder Investment Advisors Corp., and is a contributor to The Gilmo Report (www.gilmoreport.com). He actively trades his own portfolio and those of his clients.
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