The stock market is poised for a short-term bounce

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Published October 04, 2013

| Covestor

Stocks did well in September as the major indices rose. But the action was mixed: while some markets are still trending nicely, others started to show cracks.

Take the Dow for example: this index hasn’t gone anywhere since May and has been trading sideways. Then you look at the Russell 2000, the US index for small cap stocks, which has gained over seven percent during the same period. The S&P 500 is maybe the most followed index for market professionals and on the other side seems to put in a major top from a technical point of view. So is the market topping out or not? The answer is both simple and confusing at the same time: it depends on which index you look at.

Why is that? Because correlation among stocks has been declining for while. (An article in the Wall Street Journal addressed this topic in August.)  I’m not sure if that’s bullish or bearish.

What’s more important for me as trader is that I can play individual stocks from the long side in a weak market. That’s all I need to know. In addition, it makes sense to look for shorts in weak sectors. Examples in the portfolio are Citygroup (NYSE: C) and Tesoro (NYSE: TSO).

Still, market breadth has been deteriorating, similar to what we saw in August: fewer and fewer stocks have been participating in the rally. Similar observations have historically led to major market declines in the last years.

Looking at short-term price action, stocks now appear oversold after two weeks of decline during the second half of September. I’m expecting a bounce and therefore feel comfortable with current positions of the portfolio.

As of October 1, I have seven trades on the long side and only two shorts. Investors’ reaction to the U.S. government shutdown has been surprisingly muted, which suggests that these negatives had been priced in. On the flip side, participants could take the shutdown as a positive: due to its economic impact, market participants could speculate that the Fed would be less willing to taper QE3 in the near future. Liquidity continues to be seen as good for the markets.

Two sectors have been leading the rally in the last months months: Industrials and Consumer Discretionary. Recently, Basic Materials joined the party and started to outperform in mid-July. Interestingly, Financials began to underperform at the same time. So some sector rotation seems to be going on, which is not unusual in a bull market.

The key from my perspective is to focus on the health of the leading sectors – and there is nothing to complain about right now, at least from the technical point of view.

The investments discussed are held in client accounts as of September 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.

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http://www.foxbusiness.com/investing/2013/10/04/stock-market-is-poised-for-short-term-bounce/