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Start Thinking Like a Bear

February 12, 2008

By Sam Collins

The stock market opened yesterday under a cloud of concern over Dow (DJI) component American International Group's (AIG) disclosure of potential credit-related trouble. This story surfaced early last week, so it wasn't exactly "new" news. But along with some talk in Europe and this weekend's additional reports of more disclosures set to hit the financial services sector, it did make for some uneasy moments.

The financial stocks opened lower Monday led by AIG, which finished the day lower by $5.94. But Citigroup (C), American Express (AXP), JPMorgan (JPM), Merrill Lynch (MER) and a host of other banks, insurance companies and brokers closed lower. The Financial Sector SPDR (XLF) lost 60 cents, closing at $26.52 and heading for a test of its Jan. 21 closing low of $25.50.

However, the insurers were not the main story, and attention shifted to the technology shares and Yahoo!'s (YHOO) rejection of Microsoft's (MSFT) generous (so they thought) offer of $31 a share.

There was also big news for the Dow Jones Industrial Average, which hasn't had a change in its makeup since April 8, 2004. Dow Jones said that it plans to replace Honeywell (HON) and Altria (MO) with Bank of America (BAC) and Chevron (CVX). The change, they said, reflects the relative importance of the banking and energy sectors in the market. The change will be effective Feb. 19.

At the close yesterday, the Dow Industrials were up 58 points at 12,240. The S&P 500 (SPX) gained 8 points at 1,339, and the Nasdaq (NASD) added 15 points to close at 2,320.

The NYSE traded 1.4 billion shares and on the Nasdaq, more than 2.1 billion shares traded. Advancing stocks were ahead of decliners on both exchanges by a relatively small amount.

Crude oil (March contract) gained $1.82 to close at $93.59 a barrel, and the Amex Energy SPDR (XLE) gained $1.80, closing at $71.65, its high of the day. Gold (April contract) rose again, this time by $4.40 to end the day at $926.70 per troy ounce following a surge on Friday by $12.30. The PHLX Gold/Silver Index (XAU) gained 83 cents and closed at $182.08.

What the Markets Are Saying

I just read a column by a well-known technician in which he is made the case that the January breakdown wasn't all that bad, since there are some sector indices, like the Bank Index (BKX), the Homebuilders SPDR (XHB), the Retail Index (RLX) and the Dow Transports (DJT), that appear to be in the early stages of "laying the groundwork for the next bull market."

This sort of reasoning is surprising, since it is obvious from looking at their charts that, despite a quick bear-market rally that broke short-term downtrend lines -- and very steep ones at that -- there is not yet a single case of a successful test of the trend's lows.

The charts that were shown all ended on about Jan. 31 and we all know what happened since then. The nasty February start hit each of these charts hard, with both the Bank and Retail indexes closing under the tight trendlines. I'm not saying that this particular columnist is wrong, just that there is currently not a shred of evidence to support his conclusions.

This sort of "guess-work" is the result of years of an ingrained bullish bias that is prevalent with many Wall Street analysts. It's just this sort of fuzzy reasoning that led many investors to lose their shirts in the 30-plus months of destruction in the last bear market.

This kind of thinking also leads to the premise that it is impossible to make money in a bear market -- and that, too, is false. I'll explain more how to make money in a bear market in the coming weeks. But for now, I'll sum it up this way. A very good fishing friend once told me that to catch fish, you have to think like a fish -- so, to prosper in a bear market, you have to stop thinking like a bull.

Today's Trading Landscape

The following companies are expected to report earnings: Alpha Natural Resources, American Capital Strategies, Applied Materials, Buffalo Wild Wings, Cephalon, Coca-Cola Enterprises, Credit Suisse, Delphi Financial, Expeditors International, Mittel, Sanofi-Aventis, Stifel Financial, World Wrestling Entertainment and XTO Energy.

There is just one economic report due today, the January Treasury budget.

General Motors (GM) reported a loss of $1.28 for Q4 versus $1.68 last year. Excluding charges, its adjusted profit was $46 million, or 8 cents a share -- analysts had expected a loss of 54 cents a share.

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Sam Collins is ChangeWave's Chief Technical Analyst and a Registered Investment Adviser who manages portfolios for a fee. He can be reached at samailc@cox.net.