Finance: Understanding Counter Trend Rallies

PHUKET: In early March, US and global markets began a short-term counter trend rally that has seen these markets regain about 50 per cent of their prior decline. However, there are reasons you need to remain cautious by staying largely in cash.

The stock market began to rally in 2009, hitting an all-time high last summer. Since then, the market has fallen back with lower highs and lower lows. This culminated in a deep August-September trough, before a short rally and another deep January-early February trough, before the present rally.

This current rally could be the continuation of a much longer term bull market, but it could turn out to be a counter trend rally, which can also be another name for a bear market rally. However, we don’t actually know yet whether the stock market is still in some sort of a long term bull market, or has already started to enter a bear market, or whether it’s just experiencing another correction before heading higher again.

What’s important to remember is that any kind of a counter trend rally in bear markets does not last long and is usually followed by sell-offs, or new bear market lows. Moreover, counter trend rallies can be extremely dangerous for unwary investors who naturally want to be as optimistic as the financial media and think that any rally, or bull market, is continuing or just around the corner.

I suspect that the current stock market rally is a short term counter trend rally that could last anywhere from several weeks to as long as one to three months. If you are a long-term buy-and-hold investor and are still heavily invested in US or global stocks, I highly recommend raising some cash on this latest rally, and paring back the stocks that have no hope of returning to life.

You need to keep an open and flexible mind as the markets can put a long term bottom in place at any time. For now, I am closely watching the technical charts such as the S&P 500, Nasdaq Composite, Russell 2000, Dow Jones and oil for signs of a new up-trending market.

Leadership growth stocks that I like and follow are still forming out bases and we could yet start to see some good buying or trading opportunities – just like in October during the last counter trend rally. On the other hand, many technology stocks, along with key sector or regional indices, remain decidedly unhealthy.

However, there have been some signs that the iShares PHLX Semiconductor ETF and its underlying semiconductor stocks are poised to move higher. If that occurs, it will be a good sign for tech stocks and the overall market in general (including the Nasdaq composite) given that semiconductors power most of the technology that ultimately powers the global economy.

So if you are an active trader with a stomach for risk, you might want to consider taking a “hit and run” approach with selective leadership growth stocks where you buy and sell quickly once a target exit price is reached. This may mean you end up selling before maximizing profits, but you need to assume that any trading gains will be smaller as prices change quickly while the rally itself will be of short duration. You will also need to make sure that you have stop-losses in place if you do decide to take any positions of any kind in the current market.

Likewise, there is always the potential for a strong and sustained market rally, but we would need to see buyers step up (especially into leadership growth stocks) and show us with some “conviction” that the bulls (and not the bears) are back in control of the current market.

Don’t know what your current investing strategy should be in today’s uncertain markets?

Don Freeman,BSME is president of Freeman Capital Management, a Registered Investment Advisor with the US Securities Exchange Commission (SEC), based in Phuket. He has over 15 years experience working with expatriates, specializing in portfolio management, US tax preparation, financial planning and UK pension transfers. Call for a free portfolio review. Don can be reached at 089-970 5795 or email: freemancapital@gmail.com.