Preserving Capital

The 1938-42 span might be a likely scenario for the stock market with volatile, zig-zag drops and rallies but no net progress, as Louise Yamada explained here yesterday.

Unsatisfying and frustrating as that might be, it still would be a lot better than the plausible alternative — further declines in the major averages through the lows of the last bear market of 2002-03, according to the long-time market watcher and head of Louise Yamada Technical Research Advisors.

What’s not likely to happen is the more certain prediction for 2009: a revisit to the old highs any time soon. A year ago, she warned her clients that a major decline was underway. After many stocks and commodities had parabolic rises, with the help of leverage of 30 times and more, the withdrawal of that leverage has made for the dramatic declines.

Even within bear markets, impressive rallies of 20% or more are prevalent prior to stocks reaching their ultimate lows, which was the case from 2000 to 2003, Yamada observes. But they’re only suitable for nimble traders to play.

Indeed, the hopes that buying opportunities can be perilous to investors. It wasn’t the Great Crash that wiped out stockholders in 1929; it was the subsequent wrenching declines into the ultimate 1932 lows that did in the bottom-pickers, she points out in an interview.

Despite the bounce off of the market’s Nov. 20 low that took the Standard & Poor’s 500 up 24% to its recent high of Jan. 6, Yamada says there has been too much technical damage from the massive declines from the 2007 highs (47%-55% depending on the index) to consider this anything but a bear-market rally. “There is a long repair process ahead through 2009, assuming we have even seen the ultimate lows,” she writes in a report to clients.

Indeed, she says the S&P; Nov. 20 close took out the old lows. Similarly, 13 stocks in the Dow 30 also have broken their 1002-03, as has the overall Dow when adjusted for inflation.

Moreover, even “outperforming” groups merely have gone down less than the major averages. Health-care stocks, typically a defensive group, have broken down and have formed a massive top, she adds.

Beyond the need for recuperation, there are no groups that are prepared to lead a new bull market. Those typically are industry groups that have years building bases from which to launch a new advance.
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While traders might be able to play volatile swings, the parabolic rise in the bull market can result to an equivalent overshoot to the downside, she warns. That tendency leads her to prefer to protect capital in this treacherous market environment.