Apocalypse Now, or Never

06/30/2011 9:30 am EST

Focus: MARKETS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

There's plenty of hand-wringing going on regarding stocks' direction now that the third quarter has begun, but it's not time to panic…just stay flexible, says Doug Fabian of High Monthly Income.

In last month’s issue, the headline on our lead story was “Apocalypse Now?”

The question mark here was the key to our discussion, because the thrust of my commentary in that issue was that the decline in stocks since early May has generated way too much fear.

Well, since we published that issue in late May, stocks have continued their descent…so does this mean that I have changed my position on this issue?

Absolutely not.

First off, consider that since stocks vaulted to 52-week highs in late April, they are down approximately 5% through June 21.

Now I ask you, does an additional 1.45% decline in four weeks qualify as an apocalyptic scenario to you? The answer is an obvious and emphatic no. Sure, the selling we’ve seen since stocks reached their peak is certainly a correction, but it’s still a mild correction by any historical measure.

Moreover, stocks continue to find support above the psychologically and technically significant 200-day moving average. And despite that 5% pullback, we have yet to break below this level on the widely watched gauge of the domestic market, the S&P 500.

The way I see things here, we are looking at three possible scenarios which could play out over the next couple of months.

In the first scenario, stocks level off above their 200-day moving average in front of earnings season. After Wall Street digests what is expected to be a very good second quarter for corporate bottom lines, we’ll get an explosive rally that pushes the bears back into hibernation.

If this happens, we would likely trim our bond holdings and rotate more income-generating capital into high-yield dividend stocks.

The second scenario is that stocks level off above their 200-day moving average, and then stage a temporary relief rally that sends stocks 3% to 5% higher before sellers wrestle back control.

In this scenario, we could see stocks fall below their long-term moving averages. If this situation plays out, trim down your dividend-equity exposure and increase your bond and non-market-correlated positions.

The final scenario here is, in fact, the "apocalypse now" picture that sees a collapse in stocks, a steep decline in the value of the US dollar, and some nightmarish news on economic growth and jobs numbers.

And while I think there is a very low probability of this kind of doomsday scenario playing out, the market meltdown in 2008-2009 certainly proved what can take place when circumstances converge in just the right way.

Fortunately, I see no signs of this kind of doomsday scenario taking place. But as I told you in last month’s issue, if things do get dicey on either the economic front or the equity and/or bond fronts, we will know it via the price action in the many sectors we monitor on a daily basis.

By cultivating an intimate understanding of the price and volume action in ETFs pegged to key equity and bond segments, we will be provided with ample warning on any prospective meltdown.

The bottom line here is that there is no need to cower with fear over the potential of the apocalyptic scenario.

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