Trader’s Narrative

Greenspan’s comment which rocked markets yesterday, dominoed into Asia overnight and boomeranged back to the US markets (how many mixed metaphors is that?). But the market didn’t need any help from the Maestro to roll over. We’ve had three days, back to back, where the S&P 500 attempted to rally, only to be driven back by sellers. In Japanese candle-speak it formed three inverted hammers with long upper tails.

As you’ve probably heard ad naseum, the S&P 500 is about to reclaim levels it has not seen since 2000. Does anyone really believe it will plow through that sort of long term resistance without first pausing to catch its breath?

Down days like today are blessings in disguise because they make it easy to identify the really strong sectors and stocks in the market. Nevertheless, the nature of the price decline was a bit surprising.

We saw an extremely low intraday TICK, last seen at the late February 2007 correction and further back at intermediate bottoms (April 2006, May 2004 and the 2002-3 market bottom).

We also had very lopsided market internal: for the NYSE 5 declining issues for each advancer and for the NASDAQ 3 decliners for each advancing issue. The volume was even more crazy with volume in declining issues outpaced advancing ones by 7 to 1 on NASDAQ.

Usually the markets shows this kind of negativity after a significant decline has already been underway and a bottom is being formed. A sort of whoosh cleans out the longs and transfers stocks from weak hands to strong hands. As long as we are still in a bull market, this sort of market internal action is indicative of a buying opportunity.

So what now?

The first strategy is to look for weak sectors and go short (with a short-term timeframe).

A good example is the REIT sector with its anemic relative strength. It made a feeble effort to get back up to its 200 day moving average and rolled over again today. Maybe I’m wrong. Wouldn’t be the first or last time;-) I’m not yet giving up on the bear trap thesis for the REITs but if it plays out, it will work over the medium term (weeks) not over the short term. We’ll see.

The other strategy is to start making a buy list for potential swing trades from among the strong stocks that are undergoing pullbacks to break out levels.

As the funds flow data shows, a lot of the momentum is in the emerging markets. Take a look at Brazilian bank stocks:

• Banco Bradesco (BBD)
• Banco Itau (ITU)
• Uniao de Bancos Brasileiros (UBB)