Fiscal cliff, fiscal cliff, fiscal cliff. It sounds like another way to scare people away from their stocks. And it is working. Disregarding the underlying reason, 10%+ corrections happen. Every single year. Sometimes twice or more. We have watched this movie so many times before. The scenario is always the same, only the actors (the stocks) are different.
Prices change when expectations change. And this earnings season has changed a lot of expectations. Maybe the market is forecasting a recession? We all know that it is a forward looking mechanism that strives to discounts 6 to 12 months into the future. It is not always right, but more often than not it has proven to be a reliable leading indicator. The good news is that going forward market expectations are low, which means that positive surprises will have a bigger impact on prices.
Friday’s price action showed some change of character. Was it because it was options expiration day and premium sellers did their best to limit the damage or because politicians finally gave a sign that they are willing to find a solution to that “fiscal cliff” thingy? The market is oversold enough to provide some short-term mean-reversion opportunities, but make no mistake – the downtrend is still intact and guessing when it will be over could be quite expensive.
In market uptrends, buying on weakness works flawlessly. In corrections, it could destroy you – financially and psychologically. Everyone makes money during market uptrends. Not everyone keeps it when the inevitable correction comes. During corrections, it is not only important to protect capital, but also to protect confidence. During declines, there are very few decent long setups and most of the breakouts fail. If you burn yourself way too many times by being active when you should be sitting on your hands, you might become afraid of pulling the trigger when the new uptrend arrives. In the wise words of Mark Twain: “A cat who sits on a hot stove will never sit on a hot stove again. But he won’t sit on a cold stove, either”.
For the week, the St50 Momentum index lost 2.5%. This is what happens in a “risk-off” environment. Funds are exiting their long-term long positions and covering their high-conviction shorts. This explains why “dogs” like $FRO, $GME, $FB, $ANF had one of their best weeks, while almost everything around them fell apart.
I have said it multiple times on this site: Momentum stocks become primary short targets during severe market corrections. They appreciate the most during market uptrends, they are the most owned and probably the most overvalued. Funds that bought them, don’t necessarily sell them for valuation reasons because they did not buy them for those reasons in the first place. They sell what they can sell.
In corrective markets, correlations rise and almost all news is considered bad news. Actually, price is the news and prices are falling. Emotions trumps common sense. Market participants sell first and ask questions later.
During the week, one of the best performers this year, 3D Systems ($DDD) was accused of accounting irregularities. $DDD dropped 16% on the news. It turns out that the company has improperly accounted for the revenue of its new acquisitions. Nevertheless, 3-D printing is still a popular investment theme on Wall-Street. In such case, the big winner might turn out to be Stratasys ( $SSYS) and people who want to ride that trend might re-allocate capital to a company that has no accounting issues.
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Have A Great Weekend!