Market Summary

The technical condition of the market continues to decline and further losses are in store. The two charts below, of the NASDAQ Composite and S&P 500 show how the markets have fallen now for five successive weeks and that the volume trend is up. That means distribution is accelerating. Note that during the bear market rally mid-March to mid-June, the weekly volume was always below the 13 week average, meaning that accumulation never overcame the distribution that had preceded, while over the last five weeks, volume has been consistently above the average.

The optimism that followed the Bear Sterns rescue has evaporated and a new pessimism pervades the market as it contemplates the possible bankruptcy of Fannie Mae and Freddie Mac (F&F). Together they hold $5.3 trillion of debt with $3.7 trillion in mortgage backed securities. St. Louis Fed Chairman Poole estimates that F&F are already insolvent if fair value accounting rules are applied.

Adding to this gloomy picture, investment manager Bridgewater Associates now estimates that global financial losses will rise to $1.6 trillion. That is four times the value of writedowns that have been recognized so far. It is clear things are going to get worse! Just how much worse is described by Nouriel Roubini in his blog yesterday. The Professor was among the first to warn of the impending crisis back in 2006 and was scoffed at during 2007 but lately has been accorded the respect due. In August of 2006 he correctly predicted the eventual severe losses at F&F. Readers of this newsletter know we have frequently quoted him and do so again now:


Roubini recommends being in cash or inflation-indexed bonds. He is also stridently opposed to the "mother of all bailouts" that a rescue of F&F would entail. See "How to Avoid the Mother of All Bailouts".

No New Features This Week

 

Are breakouts buyable when they pullback?

Conventional wisdom has it that you should not purchase a stock that has risen by more than 5% above its breakout price. The question then arises as to whether a stock that has risen above the 5% limit and then pulled back within that range is buyable. Our Recent Breakouts report lists all stocks that have broken out in the last 90 days and indicates which ones are within the 5% limit. It also shows the highest intraday high reached until the date of the report, so it is easy to identify those that have exceeded the 5% limit and then pulled back. The motivation behind the report is to show which stocks offer a second chance buying opportunity.

A subscriber asked if there was any analysis available of how these 'second chance' stocks perform. It is not a question we've studied so we undertook a brief analysis of how these second chance stocks perform compared to those that don't pull back. We looked at stocks that broke out from a cup-with-handle base in each year since 2004 and divided them into two groups:

1. Stocks that exceeded the 5% limit within the first 30 days after breakout and then pulled back to within 5% of the breakout price
2. Stocks that did not pullback to within range during the first 30 days after breakout.

We then looked at the highest closing price achieved either before they failed (that is fell to 8% below their breakout price) or during the 12 months following breakout if they did not fail within that 12 month period.

Year	No. Brkouts	No. > 5%	No. Pullbacks	No. Fails	Avg. Gain of Pullbacks	Avg. Gain Non-Pullbacks
2004	1223	975	831	639	37.5	75.0
2005	1327	1030	852	594	46.3	75.0
2006	1272	970	822	646	38.8	67.7
2007	676	533	444	369	27.7	59.4
2008	444	319	279	137	18.8	28.4
Note: the number of breakouts fell in 2007, 2008 because we changed the watchlist criteria to only include stocks with an RS Rank of 80 or more instead of an RS Rank of 70

The results show that although the 'second chance' stocks perform less well than those that do not pullback, they nevertheless provide a very acceptable return.

We don't think this shows that you should automatically buy stocks that have pulled back within range. But what it does show is that if you hold a breakout that has not pulled back within 30 days, you should hold out for a bigger than average gain.

 

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