Practice discipline over conviction when navigating this market

Bottoms up

Commentary: Practice discipline over conviction in this tricky market

By Todd Harrison

Last Update: 12:01 AM ET Feb 13, 2008

“You should see the toast, I couldn’t even get it through the door!” — Uncle
Buck

NEW YORK (MarketWatch) — The abundance of information in the marketplace is a
lot to swallow. By chewing through inputs one at a time, the process becomes much
easier to digest.

Four primary metrics shape the tape. When viewed in isolation, they’re inherently
flawed. When assimilated properly, they serve as legs under the trading table
that balance an approach.

Last week we discussed whether or current juncture was akin to 1998 or 2001. That
destination remains to be seen but the journey is where the path to profitability
resides. It is in that vein that we scribe today’s vibe. See related column.
Click for Detail

Fundamentals

News is always best at the top and worst at the bottom. Given the decline in the
market from the October highs, we must now ascertain how much bad news is
reflected at current levels.

As of Friday’s close, with 73% of the S&P 500 having reported, Bloomberg projects
that overall earnings will be down almost 19% from the year-ago period. Some will
argue that a litany of write-downs in the financial sector skewed the data, but
it’s a flawed argument.

If I removed pizza, pasta and holiday parties from my fourth-quarter diet, I
could make the legitimate case that I’m 175 pounds.

It does, however, make the trajectory of earnings more difficult to discern.
Therein lies the art of financial prognostication and the risk of human fallacy.

If we’re to assume that the charges related to subprime contagion are in the
past, we must make the assumption that the other side of zero-percent financing
will be contained.

See related column.
Click for Detail

I would offer that a shallow, transitory recession is priced into the market but
further credit comeuppance is not. Given the recent news from American
International Group (AIG) and American Express (AXP), that’s a tall glass of
faith for the bulls to swallow.

Technicals

I’m unsure if traders follow technical analysis because it works or it works
because traders follow it. Either way, it’s got enough of a following to capture
investor attention and provide a context with which to frame risk.

Every investment professional I know is watching the January lows for signs of a
double bottom. Those levels — Dow Jones Industrial Average ($INDU) 11,970 and
S&P 500 ($SPX) 1,310 on a closing basis — are circled on trading desks
throughout the Street.

The financials and transports, both of which held “higher lows” relative to the
mainstay averages, also command space on our radar. These are considered positive
divergences and historically relevant precursors to the more widely watched
financial proxies.

As with any charts, it’ll work until it doesn’t. Hence the fatal flaw.

If the retest scenario plays out, it could pave the way for a trading rally. The
broader picture continues to warrant caution, however, as lower highs remains in
place.

In short, we’ve got room to run in the context of a bear market bounce but until
proven otherwise, that’s all it will be. S&P 1,405 (from where we broke) and S&P1,450 (lower highs) are formidable resistance levels, if and when they should
arrive.

Structural

There is a massive disconnect between what the credit markets are saying and what
the stock market is hearing. Either the former will stabilize or the latter will
follow the debt unwind lower.

Yesterday’s perceived upside catalyst was news that Warren Buffett proposed
taking $800 billion of liabilities off the hands of troubled bond insurers Ambac
Inc. (ABK), MBIA Inc. (MBI) and FGIC. See full story.
Click for Detail

Buffett is a known philanthropist but there’s nothing charitable about this
effort. Indeed, if this proposal is accepted, he’ll have cherry-picked the most
profitable part of their business and left the pits for management to choke on.
Haircuts in the neighborhood of 15% in these names yesterday support this
thought.

There are no easy answers. The debt bubble took many years to manifest and the
other side of the credit expansion will be profound. As the powers that be pull
the strings — desperate times call for desperate measures — we must allow for
relative upticks in the context of more pervasive deterioration.

The U.S. dollar remains a key structural element of this equation. Asset-class
deflation versus dollar devaluation is the toggle we together face as foreign
holders of dollar denominated assets watch the evolution unfold in real-time.

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