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BEING STREET SMART

by Sy Harding

Buy the Dip or Sell Into Any Rally?  May 21, 2010.  

When institutional investors, corporate insiders, professional investors, and hedge funds become concerned that the market has become overbought or over-valued and due for a correction they tend to sell early, making sure they will be selling into still rising prices. In fact, as their selling progresses it usually is the catalyst that causes the market to soon run out of steam and turn down even though others are still buying.

The pattern seems to have held true this time around, as evidenced by the high level of insider selling in the first quarter, and the recent SEC filings by the likes of Warren Buffett, George Soros, and other large investors who must report changes in holdings, showing they sold large amounts of stock from their portfolios in the first quarter.

Meanwhile, public investors, even if aware of the overbought conditions and expecting a correction, tend to hold on to try to get every last upside point. By definition that means holding on until the market has proven it is in a correction.

Obviously, the profit is the same if one sells early and the market rises another 5%, or if one waits until it is down 5% before selling. The market will be at the same level in both cases.

Institutional investors, hedge funds, and large professional investors deal in huge amounts of stock that cannot all be sold at once, requiring time to move. It would be a great risk for them to wait until a correction has begun before beginning to sell.

Individual investors don’t have that problem. They can instantly make a change with the click of a mouse button or one phone call. So theoretically they can wait until the last minute.

In practice it doesn’t quite work that way. It isn’t always easy to know when the last minute has arrived until after it has passed, as marked by the market being down 5%, or whatever decline it takes to convince an investor that a pullback is not just another buy the dip opportunity.

Another benefit of selling into strength is that one often gets a better price than expected, while trying to sell into a serious decline often results in selling at a much lower price than expected, as indicated by the 1,000 point ‘flash crash’ two weeks ago, and the Dow’s three-day plunge of 556 points this week.

I say all that as background to noting that in its significant plunge of the last three weeks the market has become somewhat oversold technically.

That could well bring at least a brief oversold rally.

Would a rally present a second opportunity to sell into its strength before the downside resumes? Or would it be a buying opportunity in anticipation of another leg up in the bull market, as happened after the 10% January/February correction earlier this year?

Here are a couple of things to consider if a rally does get underway.

The announcement of the $trillion EU/IMF European debt rescue plan brought only very brief relief, and then global markets nose-dived again, to even lower lows. Did that indicate that markets believe a slide back into recession in Europe has become unavoidable at this point in spite of the rescue plan, and perhaps even that the rescue plan itself, with its ‘austerity’ requirements of pay and pension cuts, and sharply reduced government spending, makes that result even more likely?

Then there is that Warren Buffett, George Soros et al do not normally cut back market exposure on expectation of only a 10% pullback.

From the technical side (which we prefer), with several of the market’s longer-term support levels broken, if an oversold rally does get underway it will probably be smart to pay attention to overhead resistance levels as possible upside limits to a rally. One such resistance level is the 20-week moving average of the S&P 500. It was previous support that was recently broken. If it now becomes overhead resistance it is about 5% above the market’s current level.

Sy Harding is president of Asset Management Research Corp, and editor of www.StreetSmartReport.com, and the free daily market blog, www.streetsmartpost.com.

These reports reflect our opinions and are based on our best judgment, but no warranty is given or implied as to their accuracy. Past performance does not guarantee future performance.

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