Stocks took a break from three days of selling and are up modestly in midday trade. Yesterday we bounced off 1,770 support that comes from October, November, and December trade.
The global rout eased as Asian and European markets finished their sessions flat or higher. This took pressure off US markets and we are experiencing a modest relief rally. While it is nice to end the emotional, sell first, ask questions later trade that occurred over the last few days, everyone is wondering if this is just a temporary reprieve before another leg down, or if this is the end of the Emerging Market tantrum.
The slide paused as all those who wanted to sell already sold. Now bulls and bears are watching intently to see what comes next. Most weak sellers were purged in the relentless, three-day implosion. Far more bold traders took their place, buying the dip and through those actions demonstrate little fear of this weakness. The remaining group of owners we have to worry about are those formerly confident holders who are now riddled with doubt and paralyzed with fear. This morning’s bounce brings them some relief, but no doubt that anxiety will flare up if prices reverse lower.
The recent slide already undercut most stop-losses, so we don’t need to worry about big waves of automatic selling if the slide continues. The biggest risk is a continuation of the pain trade where owners cannot bear the thought of losing any more money and manually pull the plug. While this dip feels dramatic, we must realize anyone holding a widely diversified basket of stocks is most likely still sitting on profits from last year’s monster gains. While theoretically money is a commodity, many traders have a higher risk tolerance for profits than principle. That means most of the longer-term holders are still quite comfortable and the only ones experiencing an inordinate amount of pain are short-term traders and late buyers of last year’s rally. Since both of these groups are relatively small compared to the broad market, their emotional selling can only take us so far. To continue the selloff, we need to flush out longer-viewed traders sitting on nice gains. That is harder to do and a large part of the reason the emotional selloff didn’t last more than three-days or push us down much more than 4% from the highs.
Expected Outcome: Cautiously Bullish – buy weakness
Anytime emotional selling takes a break, it is a good thing. This gives owners a chance to regroup and evaluate the big picture. Buyers also often wait for the selling to stall before jumping in and this pause gives them the opportunity to buy at prices we haven’t seen since October.
We typically get a couple 5% pullbacks a year. 10% pullbacks are less common and happen once a year or less. 20% pullbacks are rare and only happen every few years. Straight probabilities suggest this weakness is more likely the 5% variety than a 10% or 20% correction. When in doubt stick with the trend and the high probability trade. If buying dips were easy, everyone would be rich.
Through most of 2013, we ricocheted off each dip’s low. This rebound is taking its time. Either this is not the actual bottom, or the market’s character is changing. Both of these are concerns we need to pay attention to. Markets rarely implode from the highs, instead they step lower. So while the market might bounce here, we need to be wary of further weakness if the market is unable to make new highs.
We only make money by taking risk. Buying dips when everyone is fearful of continued selling is never an easy trade, but more often than not it is the right trade. But at the same time, there are no guarantees in the market and we always need a contingency plan. If the selloff truly stalled and the market is ready to rebound, we should not retest Monday’s lows near 1,772. Dipping under this level likely means another round of pain is coming.
AAPL beat expectations on almost every metric but iPhone sales and the stock is getting crushed for it, down about 8%. Tim Cook and bulls point to supply constraints and other issues that lead to slower sales, but Wall Street is not buying these excuses. Most likely investors are frustrated by the lack of innovation. The biggest risk is AAPL’s sentiment transition from great company with explosive growth to rock solid company with above average growth. The nuance is minor, but to the market it is the difference between reclaiming $700 and trading sideways for a decade. Many of the greatest companies in the world traded sideways following epic stock runs. There is no reason to expect AAPL’s stock will be any different. At this point we have dividends, buybacks, product refreshes, and China Mobile, but so far nothing is moving the needle. Wall Street wants another new must have device and the stock will likely trade sideways until AAPL disrupts another product category.
Plan your trade; trade your plan
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.