— Calling The Trend Column, by George Leong, B.Comm.
The current market environment requires prudence and careful monitoring, as the downside risk continues to be high despite the recent rally from the March lows. The major market indices have made a minor correction. From its mid-June highs, the DOW is down over eight percent, the NASDAQ over seven percent, the S&P 500 over eight percent, and the Russell 2000 is off over 10%. The numbers do not indicate a trend reversal as of yet, but continued sustained selling could reverse the rally back to bear market status.
Markets are struggling on renewed concerns regarding the condition of the global economies. The recent G8 economic meetings called for more stimulus funds. Clearly, the initial stimulus may not have been enough to turn the economies around. The International Monetary Fund added to the concerns after suggesting that the economic recovery would be slow. The World Bank came out and suggested that 2009 remain a dangerous year and this is adding more jitters to stocks. In our view, the news could signal a longer recession. There is nothing new here, as we had thought 2010 and 2011 would likely be the years for a sustained economic renewal.
This is a time to make sure you protect your capital and take some profits. As an investor, what are your options at this time?
Many of you trade or invest in small-cap stocks, but with the threat of a longer global recession, small-cap stocks are again vulnerable to additional selling. Smaller companies generally find it much more difficult to access financing in a slowdown. Equity financing may be impossible to attain during a bear market. Debt financing is possible, but the financing charges would likely be extremely high and take a bit out of cash flow.
The most important thing is prudence. Do not chase stocks higher on a rally; it likely will not be sustainable in the current market environment, as we have seen. If you want to trade this market by buying on dips and selling on rebounds, you will need to make sure you have stops in place just in case the support levels fail. This way of trading a sideways trading market could reap some nice gains. Pick only a few stocks. Become familiar with their trading patterns, and off you go.
Or you can stay on the sidelines and wait for things to settle down. The volatility and swings may be too much for many investors. Keep cash in higher-interest paying accounts for easy access. Do not placed funds in high-yielding financial stocks, as these stocks remain vulnerable to downside risk due to the balance sheet issues.
If you own some large blue-chip stocks, you may want to take the opportunity to accumulate shares and dollar-cost average on market dips.
Another alternative is the use of put options for a single stock or a basket of stocks. Under this scenario, buying put options to match each stock would be both economically infeasible and improbable due to the limited selection of put options. If you own a basket of stocks, look for a stock index option that has a high statistical correlation with your particular group of stocks.
There is plenty of cash on the sidelines waiting for some early signs of a market turn. Once that happens, there will be a lot of money to be made. The key is to make sure you have cash on hand to buy at some point in the future.