Despite a strong rally effort and attempt to change its character, the stock market has confirmed today that we are still in a bear. Over the past few weeks, the market was able to regain some lost ground, and three dozen or so stocks broke out from decent-looking consolidation areas (bases). However, as I have noted several times in recent months, numerous economic and political pressures seem too strong for the market to overcome. 


For the NASDAQ, the key test was whether it could punch through the overhead resistance level starting at 2600, caused by prior lows. While it made a valiant attempt, intraday reversals on Tuesday and Wednesday demonstrated that there was just too much supply hitting the market and that the indexes would turn downward. The market needs more time before a sustainable rally can take place.


Even the best chart patterns that formed on leading stocks over the past few weeks (MA, WYNN, CMG, AAPL, PCLN, V) were not able to stand up to all the selling pressure. Recently, I reestablished small positions in these stocks, only to be pushed out two days later. It wasn’t a great sign to begin with that the rally was so narrowly focused on former leaders, but when all of those breakouts began to fail, it became obvious that the fledgling uptrending market would also fail.   


But the biggest factor defeating the uptrend—one I’ve been writing about since May—is our inability to name one item, domestic or international, economic or political, that is exerting a positive impact on the stock market. Investors have been grasping for any favorable news to hold or build positions around, but they are continually coming up empty-handed. The Fed announcement yesterday showed us that while they are doing what they can, they just do not have the means to correct the numerous issues our economy is facing (unemployment, housing, a slowdown in growth, inflation fears, the budget and debt crises, political gridlock…the list goes on). Until we start making progress on these issues, they will continue to discourage demand and new investment in the stock market.


Mr. President, the stock market is telling you that Americans are not confident enough to spend money or invest in their businesses. They are not buying capital equipment, and they are not adding employees. Why would anyone take a risk with all this uncertainty? Have you noticed the unusually low number of initial public offerings this year? People at all socio-economic levels in this country are hurting. Stop the class warfare and focus on the economy. Wall Street is Main Street and has been for the past 25 years.


With these facts at hand, why would anyone want to be in the stock market? It should be obvious to all that the risk/reward ratio is and has been very unfavorable. The volatility we are experiencing continues to make the sidelines the safest place to be. For those who must own stocks or who are “testing the waters,” it is important to stay small, nimble, and to remember that you can’t argue with the market. Even the best stocks are affected by its direction.


I’m sure the next round of market commentary will be addressing the “great valuations” at hand and predicting “where the ultimate bottom lies.” Two hours after the market opened this morning, you could tell that the Dow might close down around 500 points. Based on the abrupt reversals of September 20 and 21 and the amount of sell-side volume, I wouldn’t be surprised if the market takes another single-day drop of this magnitude within the next week. Longer term, it is possible that the market might undercut the lows from summer 2010.


But that is the wrong question to be asking, anyway. Instead, we should be talking about what we need to see before we begin buying again: A bottom that is clearly in and has been retested. That’s why I’ll be concentrating on the daily market action—watching for the supply/demand balance to shift back to the long side (demand)—and monitoring the quantity and quality of the chart patterns of new leading stocks. This market directional analysis is purely technical and can only be done on stock charts of the major indexes. Until then, the sidelines are the safest place to be. Remember, cash is a position, and the stock market isn’t awarding any Purple Hearts for bravery.


Best Returns,


Scott O'Neil

President, MarketSmith


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Note: Our company maintains a small position in Apple, Inc.