A typical intermediate-term stock advance
A typical
intermediate-term stock advance
looks something like this: The big averages stage an O’Neil follow-through day*
on the fourth through 10th day of rally off a low. In light of the widespread
pessimism that usually surrounds a bottom, most investors view the fresh advance
with disbelief.
The follow-through action in the major
averages normally coincides with or immediately precedes a number of breakouts
in the growth sector. The individual breakouts themselves are decisive, strong,
and take many investors by surprise.Â
The first dozen of these breakouts often
tell you about the character of the ensuing market advance. Which group is
signaling that it’s ready to lead? In late 1990, it was a number of healthcare
groups such as outpatient/homecare and biotech. These were joined by discount
retailers like Wal-Mart, Costco Wholesale, Home Depot, and 50-Off Stores. In
mid-1993, it was the telecommunications complex that came alive. In 1998, there
were three distinct intermediate advances, each led by the Internets.
What confounds pure fundamentalists is
how a market bottom could occur when bond yields are rising, the Fed is hoisting
short-term rates, earnings growth is slowing, inflation worries are mounting, or
an international crisis rages.Â
The answer is that the market is a
discounting mechanism. It’s constantly looking six to nine months or so down the
road. Markets bottom, then, when participants are done pricing in short-term
negatives and begin to discount a rosier future.
For about 13 weeks or so off a market
bottom, scores of growth stocks break out of bases on big volume en route to
astonishing gains. This constitutes the “easy money” period, in which disbelief
abounds.Â
The best advances contain a combination
of institutional-quality leadership, like today’s Ciscos, EMCs, and JDS Uniphases,
as well as a plethora of younger, more speculative names that aren’t well-known.
Popularity in the institutional favorites tells you that the Big Money is
whole-heartedly playing the game, while outperformance in more-dynamic issues
provides some of the speculative sentiment that is so necessary for a genuine
market advance.
The current market
looks like this: We’re about 10
weeks out from the Oct. 18 intraday low in the big averages. Like clockwork, the
vast majority of the market leaders have already broken out of bases and are
materially extended from their most recent support points. If you had read the
market correctly, you’re well-positioned in some of these growth stocks that
have already rung up monstrous moves. You bought the right stocks at exactly the
right time and now you’re sitting on a plush profit cushion.
In the intermediate timeframe (several
weeks to several months), the big gains are notched by sitting through the first
correction in a stock following its initial breakout. It is to be remembered
that it takes time for a big winner to develop. On the other hand, if you
recently bought a high-flyer that was already extended, there won’t be much
technical support to bolster the stock when it inevitably corrects. That could
shake you out of a big winner just as it takes some time off for a little
r&r prior to another run-up.
As for the big averages, there isn’t
much to say without stating the obvious. Volume is going to be lax this week,
which will likely prevent the Dow from staging a high-volume follow-through to
Thursday’s breakout of a four-month cup-with-handle base.
The benchmark
techs continue to act very well, with hardly a trace of distribution.
Dell [DELL>DELL] is making noises as if it’s ready to emerge from an 11-month
saucer base–last week’s strong volume in the stock told you the move has
legitimacy…Intel [INTC>INTC] is showing some nice accumulation as it
builds the right side of a four-month base…The other chip benchmark, Applied
Materials [AMAT>AMAT], is also displaying excellent tone…Microsoft
[MSFT>MSFT], Nortel [NT>NT], Sun [SUNW>SUNW], EMC [EMC>EMC], and
Hewlett-Packard [HWP>HWP] remain solid.
color=0000FF>Setups:size=2>Â Novellus Systems [NVLS>NVLS], PSINet [PSIX>PSIX], Brocade
[BRCD>BRCD].
*Refers to the Bill O’Neil
follow-through day concept, in which at least one of the major averages rises
>1% on increased volume on the fourth through 10th day of recovery off a
market low.