an tSionna 4.28.10

Stocks on Tuesday sold off a little over 2%. It was the market's worst day since this rally began back in February. There was heavy volume, market breath was very poor and stocks seemed to have a steady bid of selling all day long. Tape readers would call days like Tuesday distribution days. While one or two distribution days does not make necessarily make for a market top, the action in underlying securities and the market's inability to reach any real rebound yesterday means that we need to be on our toes.

While the market may be using the news out of Greece and Europe as an excuse to sell, the real culprit likely is that we've experienced a great rally and stocks are tired. We are currently very over bought and I've outlined that on the chart above {double click it to make it larger}. I've also outlined on that chart certain support and resistance lines that we'll use as a guide for clues as to market direction.

Given the action we've witnessed this week I have moved my short term thinking to Net Market Negative. You can find my definition of that term here and what that means. Given the market's advance, I updated our game plan at the end of March in order to identify where I would do some selling in accounts given the unique risk reward characteristics of our clients and our investment systems. I have executed the first tranche of that plan this week.

Most of what we have sold this week has only affected trades initiated at the end of the 2009 or during the late January/early February market decline. I've also raised cash in certain accounts where this position has fallen below targets given the market's recent advance. I have not at this point taken any action with longer term positions. That could change if the market begins a more substantial decline.

Please understand that this only affects my short term thinking on stocks based on our historical studies of money flows. That stance could change rather quickly given market activity and it would not surprise me if stocks actually advance at least into the beginning of next week.  We after all are now up against certain historical end of month patterns which are often positive for stocks.   Longer term-that is looking out over the next 6-18 months-I think stocks are still undervalued.  Thus given what we know today about the economy, I would be inclined to put money back to work on pullbacks or if the current over bought status of most markets works itself out by stocks spending a certain amount of time going nowhere in the next few weeks.

Perhaps a better way of explaining my thinking is to say that stocks are currently showing a higher probability of some sort of correction occurring now than they did a few weeks ago.  I believe we need to respect that possibility. Thus I think the short term risk/reward scenario is more negative than it was a few weeks ago. Now there is no law that says that stocks might not turn around from here and confound investment professionals by heading higher. While stocks are currently over bought by my work they can also correct that phase by time as well as price. Indeed if the pattern of the last year holds then that is exactly what will happen. But if I'm wrong about my market timing for clients I will still have what I think is adequate exposure to a market rise given where we currently stand in the economic cycle. If I'm right and stocks enter some sort of corrective phase then I will have cash to look for opportunities down the road.

One final thought. I was taught by the consigliere that stocks will do what they have to do to prove the most amount of people wrong. I'm sensing for the first time in a while that what would cause the most pain is a decline and not an advance in price.

*Long ETFs related to the S&P 500 in client accounts. The above note and chart should be used for informational purposes and relates solely to the management of client accounts by our firm. Casual readers of this blog should consult their own investment advisor or do their own homework before acting on any information read here. This should not be construed as a guarantee that any future event shall occur. Since I only know the unique characteristics of my clients outside readers of this blog use this information at their own risk.