Update On Dead Cat Bounce

Today was clearly a better day for long positions and while not the best looking bounce it had its moments. Breadth improved steadily but was not even 2:1 for advances. Volume was lower than Friday but still a heavy 2 billion on the NYSE. My take is that there was some further heavy selling in the morning and that was the end of it. The rally took hold from there and progressed reasonably well. Unless there is a major shock to the system tomorrow, we should see good follow through. The bull case would enjoy healthy volume tomorrow (1.5 - 2.0 billion shares) with breadth better than 2:1. While we are ordering, new lows should contract to under 100 or so, new highs should expand but its too early in the game to expect anything more than 100 or so of those.

Last summer we had an interesting scenario unfold. As the market bottomed from the May - June swoon, volume continued light all through July and August. This vacation mode threw off a lot of players as the lack of volume was perceived to be a lack of demand. But, the demand was real and when vacations ended it ramped up even more. Drawing from that experience I would expect a similar curve. Some indicators will look good, others not. Overall, its the way our stocks behave that matters most.

So, lets talk about stocks. In my review today I found that our stocks seemed to fall into four categories:
1. Stocks that appear to not have been in correction at all: AAPL, PCU, RCI, T, DECK, SBS, etc.

2. Stocks that clearly corrected but are still healthy: LECO, MTW, JLL, AMX, CVX, FCX, etc.

3. Stocks that corrected, became damaged, and then staged a major comeback or held a support line or moving average and may be worth sticking around awhile longer: LTR, UNM, PVH, etc.

4. Stocks that corrected, became damaged, and appear to be broken: GS, AFG, X, CVG, DDS, LNC, AIZ, etc

For the first 3 types of stocks we will likely hold and possibly buy more of them. For the last one, we will sell most of these positions and replace them with new stocks that we believe to be among the first 3 varieties. In this way we will use the correction to help us. How is it possible to “use the correction to help us”? Let’s understand a correction: this is when a market starts to weaken but that weakness is either hard to perceive or appears to be a market that is resting. But, then the weakness broadens and stocks begin to fall. Some don’t and we love those. Some do but still act ok. But the ones that fall and appear to be broken are often in sectors that are weakest and will likely receive the weakest demand from new buyers. This is because something has gone wrong in the perception of their future results. Usually where there is smoke there is fire. And, as they do rally, they will run into overhead resistance, i.e., shares that were purchased at higher prices before the correction and are now being held onto for a breakeven. This makes the upside limited or difficult to come by. So, by rotating out of what appears to be bad and replacing it with those stocks that appear to be strong and in demand, we should achieve continued good results.

Let's face it, stocks like Goldman Sachs and Dillards Dept Stores are fine companies. They will go higher in time. But history says that once they are broken they will take time to clear out all the congestion. During that time they will be underperformers and act as a drag on our portfolio performance. These can be tough decisions but they must be made to keep the portfolio in 'fighting' shape primarily because we don't know what is really wrong with them nor do we know how long their perceived troubles will plague them.

So, this morning's dead cat bounce woke up some. We know what we want to see from Mr. Market and how we are going to play it. Let's see how it all unfolds...more to come.