It’s Not Terrible…And It's Almost Over

06/22/2011 7:30 am EST

Focus: MARKETS

John Bollinger

President and Founder, Bollinger Capital Management

We’re in a serious correction, but that doesn't mean investors should run for the exits…there are some oversold sectors worth your attention, notes John Bollinger in Bollinger Bands.

The strength/depth of the current correction was quite surprising. It has run 8% to 10% depending on which index you measure.

The reasons are obvious now, and can be summed up in a single phrase—"increased uncertainty." The recent spate of poorer-than-expected economic reports came at a critical juncture, just as the market was coming to terms with the idea that the Fed was going to start to step back from its sugar-daddy role.

One of the many things that the Fed has done over the past few decades is completely addict the market to its version of cocaine, easy money. Frankly, like any other addict, the market isn’t so sure it can get along without its stimulant.

So, with the prospect of Quantitative Easing ending, the recent spate of poorer-than-expected economic reports was particularly unwelcome, and led to a correction—primed further by the “sell in May and go away” chant in the financial media.

The idea of uncertainty is an important concept, as in times of uncertainty managers are reluctant to put money to work. They essentially hunker down, hang on to their cash and wait for greater forward visibility.

This is of course true for investors as well, so contributions to portfolios dry up while the cash flows needed from those portfolios stay the same. This forces the portfolios to become sources of funds. This is true whether the portfolios are stock portfolios at brokerages, mutual funds, or other equity-investment vehicles.

The grim reality is that without new contributions, markets and portfolios decline by attrition. Portfolio managers are nothing if not herd animals, and they move to position their portfolios within the emerging or dominant body of opinion.

The problem is that the tide won’t turn again until portfolio managers reach consensus and start to act en masse on the new expectations. So, we must now monitor the news looking for market reactions as clues to emerging trends in portfolio managers' outlook.

So where are we now? Obviously in the teeth of a correction, but I think we are not facing something worse.

The first fact is that the prior high was quite well confirmed, and the usual pattern for an important decline is a series of non-confirmations, which we have not seen yet.

Such a setup could develop, and it would most likely come in the form of a failed rally. At present, we are trying to forge a bottom that could lead to such a rally, but there is little evidence of success yet.

New lows have expanded over the past two weeks, dipping Net New Highs into negative territory. This time the red patch is wider (but shallower) than the others since the 2009 low, which is to say that we have spent more time in this correction, but it has done less damage.

Of special interest are the shares of large-cap industrials like 3M (MMM) or Illinois Tool Works (ITW), which have pulled back to logical places of support, and are readying another attempt at a breakout above the 2007 highs.

I don’t think that the capital-gains potential is huge for these—as they have price-to-earnings ratios in the 15 area, and are near all-time highs—but there are good trading opportunities here for the nimble.

In addition, if these industrial heavyweights can get going, it would mean good things for the economy.

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