Is It Time to 'Buy the Dip' Or Call a Timeout?

Many analysts are suggesting that the current market isn’t about economics, but rather about confidence (or a severe lack thereof). It seems that we have gotten into a negative feedback loop, especially in two areas: the Eurozone Sovereign Debt Crisis and the problems of an intertwined global economy.

However, if the market deterioration continues apace the "Buy the Dips" rule may be reinstated by the long-only crowd. Remember, as Dave M. has mentioned many times, one of the best ways for mutual fund managers to outperform (and earn their coveted performance bonuses) is to use any cash they have on the books to buy their fav’s when the market is down. And with a large percentage of mutual funds having a fiscal year-end of 10/31, we’re keeping an eye peeled for signs that the funds are putting whatever cash they still might have to work.

While this has not been happening en masse yet, we’re of the mind that this has been at least part of the reason that we haven’t seen stocks flush lower on the darkening macro picture. But before the “buy the dip” happens on a large scale, we’re of the mind that there may be more difficulty ahead.

While I am likely guilty of extremely over-simplifying, thoughts are running along these lines:

• It looks like Greece is going under.
  
• If Greece goes under next comes Portugal, likely Ireland, possibly Italy and possibly Spain.
  
• Combined they're "Too Big to Save".
  
• When they go the entire European economy (EU and non-EU combined) takes a plunge.
  
• Once the European economy crunches, who does China sell to? (Europe is a huge market for China)
  
• If China's economy also collapses (note recent Chinese and European P.M.I. figures) so does all of Asia.
  
• If Asia and Europe go, then with the U.S. consumer still in a funk the U.S. economy double-dips.
  
• If the U.S. economy takes a dive that sends negative feedback ripples to Europe.

And the cycle continues.

Recently, after yesterday's close, I once again heard talk of stocks as looking very attractive to longer term investors on the basis of two aspects:

• Relative to 10-year U.S. Treasury Bonds, the dividend yield of the S&P500 makes stocks attractive. Response: Only if earnings and dividends hold up. And even then, why buy before the collapse is mostly over?
  
• Stocks are good buy because they are "cheap" based upon their as now estimated future (2012) earnings and P/E ratios. Response: Only if the "Pie-in-the-Sky" 2012 estimates are not reduced. If the global economy does crunch then the present estimates are WAY out of line.

There will be a time for long term buying and it may not be that far away (perhaps a few weeks to a few months??). But the odds don't favor right now being that time. However, we must remember two basic market tenets:

• Number 1 - Markets bottom when things look terrible and virtually everybody has thrown in the towel. They usually begin a major uptrend long before a given recession has concluded and often while company earnings and the estimates thereof are still trending down.
  
• Number 2 - trading opportunities will continue to come and go as the market swings up and down on both short-term and intermediate-term timeframes. It is for this reason that our Daily Decision-PRO is currently 92% in cash (we bought a 6% position in the QQQ’s before the open) with only a couple of short-term “trades” on at the present time. (Editor’s note: The PRO has been up each of the last three months and has handily beaten the market for four months running now.)

Remember, this game has no end, but you can call a timeout if you wish.

Finally, let me offer these reminders. First, the decline we are seeing could be entering a self-reinforcing stage due to very low mutual fund cash levels, margin call selling, hedge fund performance pressures, and HFT trend following. Second, we are nearing month-end and quarter-end during which we could see window dressing. Or due to the decline, perhaps we should use Dave M.'s term: "Window Undressing".

Enjoy the ride. It's definitely an "E" ticket (as in the big kid rides at Disney).

 

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