Strategy for a New Leg Down  

TECHNICAL VIEW.  Written Tuesday, September 16th, 2008

A New Bear Market Leg Down Likely Starting!  Schwartz Strategy.

Right at the close yesterday, the Dow Industrials dropped sharply going from -400 points down to -500 points down, closing at 10,917.50, below its previous bear market July 15^th closing low of 10.962.50.  The S&P 500 did the same, closing at 1192.70, below its previous bear market low of 1214.91 also set on July 15^th.  Thus, after yesterday’s big down day, the Dow & S&P have both gotten back in sync to the downside with the Nasdaq Composite and S&P 400 Midcap, both of which closed below their previous bear market lows last Tuesday.  The question is which way next.  Is this breaking of support just a head fake, a false move, and stocks will ultimately hold around here?  Meaning that these new, still modest new lows are just widening out the bottom end of the trading range we’ve been in since mid-July.  Maybe if the Fed or government again rushes in on their white horses to save the day.  OR is this the beginning of another leg lower in stock prices during this grizzly bear market?  I suggest the latter. 

Bear market corrections upward usually last from three weeks to three months and take the form of either a bounce, or if technically too weak to bounce, some sideways, killing-time price action.  Earlier on in bear markets, upward corrections are likely to be just that, upward bounces, since many investors still don’t believe a primary downtrend has taken charge.  Note our recent mid-March to mid-May, two-month bounce.  But now, a few months later in this now widely-acknowledged bear market, when its more obvious that something is deeply wrong, we were only able to post a weak, one-month, July 15^th to August 15^th killing time sideways “upward” correction.  Thus I make the odds high we’re now breaking lower.

Schwartz View:  Yep, my guesstimate is that indeed we’re beginning another new leg down in stock prices.  Just common sense alone tells us after the major convulsions and damage going on in the investment banking sector, the financial & economic backdrops are in worse shape than back in July.  Thus lower stock prices should result as the market gropes for a new lower price level to make its next stand.

The next few days should tall the tale for sure about a new break lower or not, but if you agree with me, correct strategy is to again follow my Schwartz Rule:  Move Early!  That means moving today!  Shorting something today.  Whatever happens, up or down.  Remember, when cutting back after any market index or individual stock tops out, the “first loss is normally the best and smallest loss.”  Well, the same thing applies when buying or when selling short.  The first early move is generally your best.

·         WHY?  So if you haven’t been able to follow through on my consistent, persistent advice to lower your market exposure since I first starting calling this decline a bear market last November, now’s another point in time to do so.  I know, I know, many advisors on CNBC say it’s too late to sell now but I disagree.  Please remember these are the same advisors who’ve been seeing bottoms each step downward and who have to always carry a bullish market bias.  As I see it, the downside from here could be just as great as the -20%+ we’ve lost so far.  I’ve been writing that for awhile now.  And now a move to lower prices may be starting.  Thus if you have previously cut way back, to 50% or less market exposure, I applaud you since I know it’s very hard to make the decision to sell anytime, especially after you’ve seen and felt your portfolio at higher valuations. 

·         WHEN?  The other, second, fundamentally logical time to sell or sell short is in a day or two or three when the stock market bounces.  Say if we go lower for the next few days, then bounce for a day or two.  The closer to the July 15^th lows the better because old downside support, when broken, becomes new upside resistance.

·         WHAT?  As to what to short, that gets more sticky.  Remember the marketplace itself, by money once more quickly flowing into US Treasuries, is lowering long term interest rates on its own.  Thus rounding up the usual suspects, REITs, utilities and the other beaten up, battered down financials (which many still adamantly say bottomed out back on July 15^th) may not be the way to go.  Lower interest rates should take some near term pressure off these interest-sensitive sectors.  Better may be finding a way to short the real economy, namely those businesses that aren’t really financial in nature but that actually produce or manufacturer something tangible.  That’s what I’m investigating today.  To find some inverse sector funds and or ETFs which suit this purpose.