Tuesday, September 1, 2009

So what if the dips don’t hold this time?

As the stock market rally continued throughout the summer one of the cries from the talking heads was to buy the dips. With all the put and call activity there is a floor under the market that will keep it from falling below 3% so they say.

We should find out soon if the buying power of buying the dips will hold. The S&P 500 closed down 2.21% on Tuesday. If the dip is going to hold, the dip bottom should be around 991 on the S&P 500. If we break 991 then I believe we could have a series of downdrafts that could take us down to my original target of 900 to 910 on the S&P 500.

Over the summer, as the market rallied, the talking heads were spouting about how much the market is up from its bottom. The S&P 500 is up about 48% from the March 9th bottom, but the rest of the story is that, on a year to date basis, the S&P 500 is up about 11%. If we fall to the 900 to 910 on the S&P 500 we would be, in effect, winding up flat or with zero return for the year. The idea of losing all of the recovery will cause people to react quickly.

We may well have seen the high for the year in the market and if we get to a point where the market drops 5 percent then look for panic selling to increase by those investors who want to protect any profits they have left.

Buying the dips reminds me of the story about the little Dutch boy who stopped the leak in the dike by putting his finger in the leak until someone could come and plug the hole. The pressure of all the water behind the Dike could not be stopped by one finger.

The pressure from many investors who have seen some recovery in their portfolios will act like the water behind the dike. Once the crack begins to open it becomes impossible to stop the onslaught of water coming through the dike. Investor psychology is like the water behind the dike. Once the water starts flowing through the crack more water wants to get through the dike. When the market psychology changes to the point that investors want to get out, the pressure on the markets increases. If we look at what happened in the period from September to March investors were panicked and wanted out at any price. While I do not envision that type of panic selling this time around people will react quickly to get out of stock positions because they do not want to see again the losses they experienced over the last 12 months.

When you start getting nervous about the market and you want to get out you need to think about what you are going to do with the money. According to Barron’s online the average US Government Money Market Mutual fund is yielding on average 3 basis points with On the other hand hundreds of them offering zero yield.general money market mutual funds are yielding 6 basis points but like many of the Government Money Market Funds many of the general money market funds are also yielding zero.

Know where you are going before you go. The old Chinese proverb says, “If you do not know where you are going any road will take you there.” Don’t make decisions under stress. Look at what you own and ask yourself where else you would go with the money. If you can’t find a really good alternative then stay where you are. You need to look around and see how many other people have their finger in the dike.

Dan Perkins

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