To OTC Journal Members: 
 

Down Cause We're Down

The last three weeks have been pretty rocky- the market has definitely changed character and we're clearly in a corrective phase. Here's a stat I heard last week that was kind of eye opening and puts the market's mood in perspective as it relates to earnings season:

• 20%- that's the average tech earnings beat- this means the large cap tech stocks have beaten the analysts estimates by 20% on average.
• 10%- that's the average amount tech stocks have fallen after an earnings release

What's changed? Let's start with this chart. 

This is the ETF UUP. This ETF mirrors the value of the Dollar. The Dollar has been strong of late, and it hasn't been good for the stock market. The stock market gave us a fantastic ride from the low back in March to the January high. It became the expected norm for stocks to go up again.

During the entire ride from March to January, the dollar kept dropping. This was the world's response to our policy of printing money to buy our way out of recession. When the dollar goes down, US Equities become cheaper to International Money. Their dollar buys more. In fact, there's another of these giant carry trades in place. The huge institutions were shorting the dollar, and investing the money in US equities. This allows them to double dip with the same capital.

Lately, there's been a slew of negative news out of Europe. Greece is in big trouble on its debt, and Spain and Portugal are not far behind. It's caused a flight out of the Euro and into the Dollar.

This has resulted in another unwinding of a carry trade- short the dollar and long US equities. To unwind, these huge players must buy back the dollar, and sell US equities. Hence, the recent negative tone in the market.

So, where to from here?
 

A Reasonable Retracement

Q4 of '08 and Q1 of '09 are still a little too fresh in people's minds. There's a certain level of fear we could return to the complete debacle we lived through then.

Markets are like pendulums. The bigger they swing one way, the bigger they swing back. We had the mother of all swings in that '08/'09 down draft, and a huge swing back in the other direction from March to mid January.

The swings will continue, but they without the same magnitude. Is the dollar's strength really a reason to panic and get out of the market? Hardly. The market has been selling off because it was ready to. It was just looking for an excuse to get into a corrective phase after 10 months of moving up, and the dollar strength just provided the excuse.

Here's a weekly chart with an awful lot of stuff going on. It measures the S&P 500 from the March lows, and tries to predict where we could end up as this corrective phase runs its course.

The S&P has come off 9.2% from the top. About a 10% correction, but I don't believe it's enough. I believe the S&P 500 wants to put in a full 15% correction before resuming it's upward climb. We're 2/3rds of the way through this.

I like 15% because it represents a nearly perfect 38.2% Fibonacci Retracement of the entire Mar to Jan move in the index of the behemoths. This is a logical and totally acceptable correction in an ongoing bull market- a bull that has several more years to run its course.

As you look at this relatively crazy chart, I'll explain what I believe might happen- or at least has a high probability of happening. 

There will be a bounce in the S&P before we head lower. The bounce will take us back to about 1110 before resuming the final leg of the correction. 

Once we start into the final leg, we'll head all the way down to about 975, where there's a big confluence of technical indicators suggesting there will be major support. Money that missed the huge 9 month rally will come back in, and we'll be off to the races. 

I believe there's a relative high probability this scenario will play out, but I just don't know the time frame.  It could take a week, or we might grind all the way through the summer to get through this process.

Once we do, get ready for the next big leg up. I hope it doesn't take through the summer, and I believe it's unlikely for one simple reason: Markets tend to go up a higher percentage of the time, but when they go down it happens a lot faster. Fear is a stronger motivator than greed, and the hedge funds tend to pile out of things faster when the fear factor kicks in.

Since the bullish phase took 10 months to complete, it won't take 8 months to complete the correction. It likely will happen much faster.

On the small stocks- that's a different breed of cat. The interest in small stocks has completely vaporized, which is extremely bullish to me. Most smaller stocks- the China situations and the like, have already fallen 20% to 40% from their tops. Every stock from China Education (NYSE: CEU) and Universal Travel (NYSE: UTA) to Spicy Pickle (OTC BB: SPKL) have been crushed, and the low volume sideways trading phase has begun.

These kinds of stocks are likely at the bottom now, and buyers should resurface in reasonably short order. I can't promise there won't be another leg down, but these stocks have run through normal corrective phases. When volume comes back, they will move up rapidly.

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