Reconsider the Source

In August we ran a column entitled Consider the Source. It was in response to Rochdale Securities’ analyst Richard Bove’s call to sell financials because they were “trading on fumes.” We argued that Mr. Bove has a poor track record of calls, having implored the retail public to buy and hold banks all throughout the market implosion last year. Fortunes were lost heeding his advice.

After Mr. Bove’s call financials, as measured by the SPDR Financial Sector ETF, went on to gain more than 10% to their recent peak and the market moved higher as well.

We mention all of this because late in yesterday’s session Mr. Bove issued a Sell recommendation on Wells Fargo (WFC). The stock promptly tanked on enormous volume taking the market with it.

While readers of our prior column know what we think of Mr. Bove’s acumen we would be remiss if we didn’t remind ourselves that even stopped clocks are correct on occasion. And while the market eventually disregarded Mr. Bove’s previous negative prognostication this time it appears it seized on it as the excuse it was looking for to do what it wanted to do: sell off.

We view yesterday’s closing action with alarm. The market has been having difficulty moving higher on good news and traders are clearly taking profits while they can. Given the increased distribution we have seen of late along with other clear sell signals, like the break of an increasing number of stocks from their bullish uptrends, the failures in the moves of individual stocks to new highs, the divergence in the 52 week high list, and major market leader AAPL’s euphoric rise through its upchannel line (which we have well chronicled here and on our sister blog) we believe the market could be in line for the first significant correction of the bull market.

(NB - 52 week highs list divergence – In a previous column we pointed out that markets tend to peak when the major indices hit new highs with fewer 52 week highs than previously. Yesterday, as both the NASDAQ and S&P 500 hit new recovery highs, the indices scored only 451 52 week highs as opposed to nearly 700 when the indices hit new highs on October 14th.)

We previously stated that we do not believe the current bull market will end before the Fed begins to cut back on the excessive liquidity in the market. While Fed and Treasury policies have clearly debased the dollar and unleashed inflationary trouble signs in oil and other commodities, that time has not yet come. Given this and other bullish signals we see around the world, including the outperformance of commodity based stock bourses, such as Brazil’s, and the resurgence of China’s market which we chronicled recently, we expect this to be a constructive consolidation. But it is likely to exceed the 4 – 8% corrections we have seen to date. This might well be difficult for longs to sit through and we feel you should act defensively, raising stops in winning positions.

As always we could be wrong. An extended correction does not have to occur. But given the minimal gains off the last market pullback and the lack of participation since then as measured by lower trading volumes as the markets moved higher, we feel caution is the prudent position at this point.

Given that we expect a constructive consolidation we will be profiling on our sister blog those sectors and stocks that we think you should focus on as a correction unfolds.