Anyone trying to predict next year’s stock market is nuts. No one can consistently and accurately foresee what the market will do, especially this news driven market. Nonetheless, there is no shortage of people predicting that 2012 will be a good, even a great year. Most are citing low stock valuations that “continue getting better.” Others have noted that election years are typically good for the stock market. While both predictions contain some factual evidence, at the end of the day, all predictions are ultimately opinions. And positioning now for a theoretical rally based on an opinion is dangerous.

 

MarketSmiths do not invest based on predictions. We invest based on facts and proper market interpretation. We hold a set of expectations for what a healthy market should do, then before we commit capital to the market, we wait for confirmation that those expectations have been met.

 

For example, after a new rally in the market begins, we look for confirmation of strength and institutional participation in the form of a follow through day (FTD): a day where a major index is up at least 1.7% in price with higher volume than the previous day. A great example is the NASDAQ FTD on October 18, 1990. Typically this occurs 4-7 days after a new rally begins and significantly increases the chances of a sustainable uptrend. No bull market has ever started without one. We also look for technical strength and recognizable chart patterns on leading growth stocks with the emergence of leadership in traditional growth industry groups.

 

Waiting for confirmation allows us to protect our capital for the next bull market. Being patient can be difficult, but it is reassuring to know that if a new rally is real, there will be plenty of stocks to choose from and time to capitalize on it. Don’t get me wrong, I’d love to have a good market to operate in. But before investing aggressively on the long side in 2012, investors should be looking for the environment to prove itself in the following ways:

 

  • A FTD, as described above, accompanied by leading stocks breaking out from sound consolidation areas (recognizable chart patterns.)
  • Because the market environment has been so poor, I’d like to see a second FTD. Given the lack of conviction seen in individual stock breakouts and weak rally attempts lately, the next market rally needs to prove itself, in a big way.
  • I’d like to see at least one real catalyst. None of the major economic or political issues weighing on the market have been resolved.
  • I’d also like to see more new issues in the IPO market.
  • New leadership should be emerging in traditional growth industry groups (such as, financial, technology, retail).
  • Fewer short setups on leading growth stocks and more constructive long chart patterns.

 

Keep in mind these are not predictions, but rather expectations that may or may not be met. Until they are, keep your powder dry and your watch list fresh. Our day will come.

Best Returns,  

 

Scott O'Neil

President, MarketSmith Incorporated

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