Looking for a Bottom
The market is searching for stability
Hello, and again thank you for reading.
It was again a bruising week for portfolios. What is difficult this time, unlike past market conundrums is the added uncertainty caused by Covid19. Trying to calm an anxious market is doubly hard if there is a pandemic.
After all the destructive forces of the falling market, after the pain and suffering because of the added uncertainty, it is only natural for investors to ask, where is the bottom, or at the very least, when will the carnage stop.
We could see more rallies and more drops as time progresses. It is because for the meantime, there is not yet any announced cure for the disease, nor adequate financial stimulus has been really accepted by the market.
The disease is still circling the globe.
The government will do its best to try to shore up economic policy through QE and the like, but until the disease shows signs of a “bottom”, i.e. a cure, the carnage will at best be like trying to control a muffled lion trying to free itself from its bounds.
Characteristics of a Market Bottom
A true market bottom is discerned by the basing of a stock. And I am sticking my neck out that this will not be a”V” shaped recovery.
A basing action is similar to Newtons Third Law which states” for every action, there is an equal and opposite reaction”.
Imagine a rubber band stretched horizontally between two points. If you pull downwards in the middle and release, there will be a series of vertical upward and downward moves with diminishing velocity. Similar too a bouncing ball, if you throw it on the ground, it will bounce in diminishing arcs.
A stock which free falls from a gap and closes at its low will rally at least fifty percent the following days in a weak market and more in a strong market.
If it is trying to form a base, it will then fall not as steep as the first fall, then rally, and so on in ever diminishing volatility. Alternatively it will form highs and lows as boundaries where prices will bounce around between these points.
This is a basing action. Temporarily, the decline has stopped. It means buyers and sellers are more or less equal. Supply and demand are at equilibrium.
At anytime, however if there is news, good or bad, this base can be interrupted by stronger selling or stronger buying depending on what kind os news.
In our situation, if the government provides easing benefits, and the market thinks its sufficient, then this base could start forming, and declines temporarily halted.
However, If the otherwise is true like what happened last Thursday, where a 2000 point drop in the Dow occurred, then the base will break to the downside.
If a cure is found, while the government has provided adequate financial stimulus, then the market will break to the upside and start a rally.
If the cure is valid, and the financial stimulus takes hold, and businesses start to recover, then it could be the start of a real base, and the start of an upward advance.
What to Do in The Meantime
Timing the market or assuming that the basing is about to start is difficult. I always wait for a basing action by checking to see if the horizontal chart action starts, and from there decide if its strong enough to commit to more buying or wait until there is final proof of recovery.
Below is an example of a temporary base which did not hold, and a break happened to the downside.
As a rule, the longer the base, the more validity it has.
After a sharp drop to 27, LK rallied to 39 then formed a temporary bottom at 34. It then rallied to 43 and then went back down again to 34. These points established a temporary top and bottom, and a basing action started. However, the effect of Thursday’s selloff was too strong due to the markets perception that the governments response was inadequate, in which case LK dropped to 30. The market rallied Friday after the market perceived that the newer stimulus package was better and closed at 32.91 on Friday 13th.
I have been keeping my powder dry. Right now, I am all cash. The market could rally on Monday, but until a cure is announced, the market will always be looking its shoulder to see, if businesses are starting to recover, and the consumer is again alive, and thus a recovery could be starting.
I will be doing short term trading, scalping if you will and think hard whether to keep an overnight position. With an abundance of caution, I shall let the pros take the risk and observe.
I don’t know where the bottom is and i’m not trying to call it. But if and when it happens, and it’s valid, I will surely start positioning.
It is interesting to note that Bridgewater, run by Ray Dalio has been quoted by Marketwatch that its flagship fund, which has made money for the last 20 years is down 20%. Who knows how many more money managers out there have been hit by this market.
This just tells us that this is indeed a different kind of conundrum. Even Warren Buffet is saying that it’s the first time he’s seen the market in this kind of situation.
I think the bears are still in control, and they are still selling the rally, and that the market is still treading water.
Please be very careful
Disclaimer: The above is the authors opinion and is not investment advice. Please consult a registered investment adviser for any investment decisions. Investments can lose value.