Why the bear market is finally ending
David Russell | firstname.lastname@example.org
I began my career covering U.S. financial markets on April 1, 2000, less than three weeks after the peak of the Nasdaq bubble. I watched hundreds of stocks go to zero and witnessed the collapse of an entire industry of high-fee, growth-chasing tech funds. I saw Johnny-come-lately Pets.com sink into nothingness and witnessed the implosion of Worldcom, Enron, and later much of the U.S. financial system.
But something has been changing in the last few months. Bad news is increasingly shrugged off or ends up being not so bad after all. Greece and Spain have, for all practical purposes, already defaulted, but the euro has rallied. The U.S. economy has slowed but is still growing. China is worsening, yet steel, coal, and copper appear to have bottomed.
It's hard to know how exactly how the new bull market will unfold. Precious metals, agriculture, and domestic energy will probably be involved, but so will countless other stocks that get less attention, such as deathcare and firearms (two groups that interest me). But they usually begin quietly with large numbers of so-called experts remaining highly skeptical, which has been the case for the last few months.
The fact they're skeptical means that those same people are not in the market. That's actually bullish because stocks will go up as these investors come off the sidelines. The recent lack of selling pressure is another positive.
Since early August, the S&P 500 has ground higher, slowly but surely, with plenty of opportunities for people to sell at the highs. Yet it simply hasn't happened. This has been especially true in the last week.
There are reasons, obviously, to be cautious. Most people will cite "worries about Europe" or "a lack of stimulus from the Fed," but I see things differently. For me, the main concerns are technical chart patterns--namely, bearish momentum potentially affecting many charts.
The euro is a case in point. The CurrencyShares Euro Trust (FXE) has been getting squeezed higher and is now parked at its 200-day moving average. Does it keep rallying straight up? There is a good chance that the answer is no.
The same is true for a stock like Alcoa (AA). The downside risk looks minimal because it has formed some substantial support around $8 and could now be coming back from the dead. But it too is sitting at its 200-day moving average.
In my view, options make it easier to play these names. For example, we know that AA will probably hold $8. You can sell the October 8 puts for $0.05 and buy the October 11 calls for the same price, so you will pay nothing but the commission. If AA rallies, you'll clean up. If it drops to $8, you'll buy shares, but you'd want to buy at that support level anyway.
And if it does nothing, then the whole position simply goes away. That way you have long exposure but don't have to mess with all the back-and-forth that could occur at these levels over the next few weeks.
Alternatively, you can use the "strangled long" strategy: Say you want to own 200 shares. You then buy 100 for about $9.40 while selling 1 October 9 put for $0.23 and 1 October 10 call for $0.15, lowering your cost basis to about $9.02.
If it pulls back to $9, you get assigned another 100 shares for that price but, including the credit earned, that second block of stock would cost you $8.62. If AA rallies to $10, you will have to sell your 100 shares for that price. But including the credit, your effective exit would actually be $10.38.
Turning to researchLAB, two groups that have been grabbing some attention recently are the cruise ship operators and the commercial real-estate management companies. Both got battered by global economic worries, but they've also been outperforming the S&P 500 in the last month.
And don't forget about obesity drugs, which have pulled back after huge rallies and could now be ready for more upside. Finally, here are two smaller individual names trending higher that are now showing some nice pullbacks:
3D Systems (DDD): Seems to be bouncing around the same $37 level where it peaked in early July. Earnings have been so-so, but revenue is growing around 50 percent a year and short interest is more than 30 percent of the float.
StemCells (STEM): It started lifting in July after its use of adult stem cells showed promise treating Alzheimer's disease. Earnings were good in August and more positive data followed on Sept. 4. Small drug developers have been hot for more than a year now as potential takeover candidates, and STEM could now benefit from that trend as well.
(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Sept. 12.)