Markets & Finance

"If It Walks Like a Bear..."


This is a time for patience and for examining fundamentals such as a company's balance sheet, says Paul Cherney, market analyst for Standard & Poor's. Cherney, whose forte is technical analysis, sees August as the earliest likely time for a bottom for stocks and the start of a sustainable advance.

When an advance does come, he thinks technology stocks will lead the way, just as they led the way down. The upward spurts so far he considers mere rebounds from an oversold condition. Meantime, he observes that trying to pick a bottom is like "taking aim at your foot with a loaded gun." For a turnaround, he believes, institutional money must be convinced that the worst is over and corporate earnings will improve.

For investors heavy on bonds, he suggests not returning to stocks until the Federal Reserve Board meets two times without cutting interest rates.

These were the among the views Cherney expressed in a chat presented Mar. 22 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts from the chat follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: First, Paul, the Dow was briefly in bear territory today, and all the other indexes except the Russell 2000 are already there. Do your charts show a true bear market?

A: If it looks like a bear and walks like a bear, it's a bear. These are bear markets.

Q: O.K., where is the bottom?

A: It's difficult to say, but today's price action was a capitulation in volume. The rise at the end of the day was short-covering, which is the first step to a reversal. I doubt that this is "the bottom," but we are ready to attempt a 5- to 15-day advance.

Q: Would you define "capitulation" as it applies to the market?

A: "Capitulation" is a "give-up" by bulls. People who have been long on a stock finally cannot take the pain any longer, and they sell. When their selling is met by buyers and the reverse in price to up is accompanied by a spike in volume, that is a sign that you may have exhausted the sellers.

Q: Is there hope for any time this year?

A: For the bottom? I would say August is a likely time for the beginning of a sustainable trend higher. Whether we'll be higher or lower at that time I cannot say with any certainty.

Q: What do you think a small investor should be doing in a situation like this?

A: Have patience. Trying to pick bottoms in this market is like taking aim at your foot with a loaded gun. It is too easy to shoot yourself in the foot. Let a bottom become obvious and a trend higher develop -- then move into the leaders.

Q: What is the next sign we should be looking for as far as a turnaround?

A: I would like to see an advance -- a retracement, which finds buying support at or near the existing lows and then a move above the high point that occurred between the initial low and the retest low.

Q: I have a lot of money in bonds right now because I felt this was coming. When should I move my money back into stocks?

A: When the Fed goes two meetings without cutting rates.

Q: Paul, did you or any of your charts see this coming?

A: The break below 2188 [on the Nasdaq] most recently was a breakdown with bearish implications as far as my view of the charts.

I became short-term bullish when the Fed did its surprise rate cut Jan. 3, but four days into February, most of my intermediate-term indicators, which had been negative since May, remained negative, and I became very concerned about additional downside. Nothing that I have seen can be described as anything more than rebounds from oversold in a declining market.

Q: What about the tech stocks generally? Any broad sense of how they might do? And any particular standouts, up or down?

A: Usually, in an oversold rebound, the techs have led the way out for the past few years. The stocks that sell off the hardest find the greatest buying support because much of the decline was the product of short-sellers who are forced to buy to cover.

So in the short run, techs (the usual list -- semiconductors, computer peripherals, software and services, networkers, communications equipment) will attempt to rally and will probably see the best short-term advance, but the fundamental story will prevent them, I believe, from trending higher at this time.

Q: What do you think about Citigroup (C)?

A: Financials are usually good performers when the Fed is easing. Today's price action in Citigroup looks like a short-term capitulation to me. However, once again, trying to pick a bottom is dangerous.

Q: What books, if any, would you recommend to someone just starting technical analysis and looking for an overall view of the market?

A: I have a standard response for a good introduction to the markets. It is Secrets for Profiting in Bull and Bear Markets by Stan Weinstein. Also, if you're more short-term-oriented, any of the Market Wizard books are good.

Q: It looks like there are a lot of bargain stocks that are undervalued -- even ones that pay good dividends. Do you agree? What brokers like to call "buying opportunities." Even now?

A:: I would say that, as long as the dividend appears secure, it is not a bad time to diversify a little into a stock that will pay you for owning it on a basis other than a capital-gains play. The day of 85% up in a year is over for a while. Patience and earnings and solid balance sheets are now the rule of investing again.

Q: Tax cuts might not have an immediate economic effect, but will they have a psychological effect? Guess you can't chart market and consumer psychology!

A: Not with the size of the tax cuts I'm seeing bandied about. The problem with the markets right now is the excesses of the past. A trend higher will not develop until institutional money is convinced that the worst is over and that earnings can grow.

Q: Isn't it also important for capital spending on technology to get going again?

A: Absolutely. And if you think about the real problem that cut the legs out from underneath the tech stocks, ironically it was an old-fashioned inventory buildup. The reasons for it had a lot to do with the capital spending done by the dot-coms with speculative money raised through IPOs. But as they ultimately failed, demand for high-tech switches, boxes, etc., fell off the cliff. And all the ramped-up production ended up filling the inventory warehouses.

Q: What part of the market do you think will turn back up first?

A: Techs. As the selling finally hit the more traditional financials and industrial cyclicals over the past eight trading days, the techs only participated until yesterday. Even though they moved lower, the momentum to the downside is waning.

Q: Would it be a good idea to transfer money from a balanced fund to the S&P 500 now?

A: Diversity is the hallmark of a good portfolio. Just ask anyone who was 100% tech and stayed that way. A portion in a balanced fund is good. A bigger portion in the index fund would also be good. Diversity is the most important thing because no one can call the market all the time.

Q: Do you have any observations on small- and mid-cap stocks in this unsettling environment?

A: I think that right now you have to look at the standard balance-sheet items when trying to pick any stock. In a bull market it is so easy to make money that everybody seems like a genius. Stocks just keep moving up. This is not a bull market, and therefore each stock has to be judged by its own merits. A solid balance sheet and good prospects for earnings are paramount. And patience.

Q: So would you sum up what your charts tell you about the coming weeks for the market -- and investment strategies?

A: I was impressed with the price and volume action today in the equity markets. The first step to a reversal begins with short-covering. We had that today. Momentum players and bargain hunters also enter in the first couple of days of a reversal. Their buying is usually over within one to four trade days. A retracement usually follows.

If longer-term investors are convinced that there is some enduring value at these levels, then they will step to the plate. Only a move above the initial high that we are hopefully going to see in the next couple of days would be a sign that additional gains in the short run can unfold. Ultimately, though, I have to tell you that I believe that whatever gains we have over the next 5 to 15 trading days will unwind with a retest of the lows we saw today. We have no trend higher yet. A prudent observer must exercise patience.


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