Rough, But Worth the Ride

07/06/2011 8:30 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Aside from last week, the market has been rather tough on investors. But don't throw in the towel—long term there's more upside than downside, writes Dan Sullivan of The Chartist.

As of mid-June, Investors Intelligence had the number of bullish advisors down to 37%, versus 57.3% ten weeks earlier. The current reading is the lowest since September of last year, which turned out to be a good buying opportunity.

The American Association of Individual Investors in their weekly poll now shows the number of bulls at 24%, versus 48% bears.

The last time they were lower was August of last year, when the bullish contingent came in at 21%, versus 50% bears. This turned out to be an excellent buying opportunity.

Whether history is about to repeat remains to be seen, but sentiment as well as our oversold readings have certainly moved in the right direction.

The CBOE Options (equity only) put/call ratio index was 1.11 on June 15. More puts bought than calls. This is the highest single-day reading since the 1.18 reading on September 11, 2008, after saw the S&P 500 dropped 3.4% two days earlier.

The event which triggered the extreme loss of confidence was the bankruptcy of Lehman Brothers, which was formally filed on September 15 of that year.

The prior high reading of 1.35 occurred on March 13, 2008. The event triggering this extreme reading was the total loss of confidence in Bear Stearns’ ability to stay in business.

In a Fed-arranged marriage, they were taken over by JPMorgan Chase (JPM). Their demise was traced back to subprime mortgages.

The current high reading perhaps is related to the possibility of the default of Greek sovereign debt. In a flight to safety, MarketWatch reports that the yield reached an “all-time” low of 0.3% on US two-year treasury notes recently.

Obviously, the complacency of late April has been replaced with a great deal of concern, which is usually the case during the throes of stock corrections.

In our opinion, the current sell-off represents a correction within the confines of an ongoing bull market. The recent sell-off in many ways was long overdue, considering the fact that the Dow Industrials had gained 32% from July 2010 through its most recent peak on April 29.

And while the Russell 2000 surged 44% over the same timeframe, that is an incredible move considering it occurred in only ten months. Whenever a primary bull market encounters a pullback of the current magnitude, the doom-and-gloomers become increasingly shrill, and it can be unnerving to many investors.

The truth of the matter is that corrections are inevitable. A bull market is never a one-way street. Even during the most powerful bull market, there is going to be corrective activity which sets the stage for the next move up.

Two of the most difficult but crucial cornerstones of our investment philosophy are:

  • employing a stop/loss strategy;
  • and being willing to risk paper profits during inevitable market corrections, with the goal of long-term gains.

Right now, the latter part of our strategy is being tested.

With our models in a positive mode, our advice for long-term investors is to stay fully invested. Traders are advised to continue to monitor mental stops on a daily basis.

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