Rallying Markets: The Weakest of All Four Seasons
By Ann Sosnowski
In this article
A 7% to 10% difference between major market equity prices and 200-day support usually calls for a slight market correction.
The Dow Transports Index has moved the most this year, a gain of 15.64%, making the Russell-2000 and the iShares MicroCap Index more desirable investments comparatively.
Buying larger cap stocks right now could mean that you are getting in at the top of a rising and falling cycle.
Rallying Markets: The Weakest of All Four Seasons
The summer rally starting in June is the weakest of all four seasons.
Over the last 12 years, the S&P has been up nine Junes, and down three, with an average gain of only 1%, which ranks seventh out of all 12 months.
But is there a change in the air this month? The S&P hit a new 52-week high today of 1,535.56 as the major American index is flirting with a new lifetime high currently at 1,552.87 from March 24, 2000.
According to Michael Patterson of Bloomberg, companies in the Standard & Poor index are still at bargain prices, as the total 500 companies are trading 45% less expensive than they did during the peak in 2000. Not only that, but they're 30% cheaper than the low in 2002 of S&P 768.
But what about other gauges of the American market? While the S&P has gained 8.11% over the course of 2007:
The Dow Jones Industrial Average has moved 9.58% in the same time period…
The Dow Jones Transports has moved an amazing 15.64%, verifying the Dow rally…
The Russell-2000 has underperformed, up only 7.48%, and the I-Shares MicroCap Index (IWC) that Diligent Investor MicroCap Hot Sheet subscribers are holding has been up a measly 3.21%.
Rallying Markets: Fear Creeps In Between Price and Support
The Dow Jones Industrial Average is currently trading extremely far from its 200-day Moving Average. When these large gaps between the price of the major market and its major technical supports occur for too long, major corrections occur.
Just look at what happened in May 2006. The Dow was trading at a high of 11,670 while the 200-day Moving Average was at 10,814.42, a difference of 7.91%. Over the course of the following month, the Dow retraced to its 200-day Moving Average.
Again in late February of this year, we saw the same large gap between price and major support. The Dow hit a high of 12,795 while its major support ran below at 11,745.39, a change of 8.9%. Spurred by rumors that the Chinese markets would not be able to maintain their strength, the Dow corrected almost down to that support.
In my mind, a difference of 7-10% between major market average prices and 200-day Moving Average support is cause to start rallying behind a correction. As of the Dow's most recent high of 13,673, the top 30 American companies are trading an overwhelming 10.9% away from major support.
While I'm not a bear in the long term, as I'm loving the recent rally and what it's doing to the Diligent Investor portfolio (open positions are up a total 441%), there's no doubt that if this is going to be another long-term bull market, another correction is due.
And it seems to be right on time, correlating with the summer months.
I would heed caution right now buying any stocks that move in tandem with the major market averages. While they are undervalued, the odds are if you buy them now, you're getting in at the top of what will be a rounding cycle.
For the long term, I'm still extremely bullish on the iShares MicroCap Index (IWC) and the Russell-2000, as they have been known to outperform the major market averages and also take less of a hit during major corrections.
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Ann Sosnowski is a small and mid-cap stock analyst for Taipan Financial News. She is the editor of Diligent Investor, a monthly newsletter that balances conservative and moderately risky investments that pertain to current market trends. She is also the editor of Diligent Investor Micro-Cap Hot Sheet, a monthly newsletter that finds the hottest penny and micro-cap stocks on the market.
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