Zero-Sum Game
07-Sep-00 00:05 ET
[BRIEFING.COM - Gregory A. Jones] In the long term, the stock market is anything but a zero-sum game. Everyone playing this game understands very well that stock prices trend higher over the time, creating far more winners than losers. But in the short term, markets occasionally languish, and when they slump into these rangey moods, trading strategies must change. What worked in last fall's momentum frenzy won't work in this fall's sober range-trade.
The first point that needs to be made is that the market is indeed in a range. The Dow first crested the 11,000 mark back in April 1999. That's 16 months of zero-sum action. The
Nasdaq's zero-sum incarnation is young by comparison, stretching only four months, but it might prove to be every bit as durable as the Dow's.
A slowing economy and extreme valuations are fundamental reasons why the Nasdaq is not going anywhere soon. But the shift that made those factors important was this spring's Nasdaq correction, which popped the bubble for good (or at least until the next one comes along...).
The Old Math
Last fall, if a stock was up 20 at noon, you had to buy it because it would close up 35, and then gap up another 10 the next morning. There was no buying the dip, because the dip didn't happen. It was a momentum-driven bubble that took nearly every tech stock along for the ride. Trading the market became little more than a game of identifying a momentum sector early and staying with it. But ultimately, this type of investing becomes little more than a ponzi scheme. There were clearly stocks being driven by nothing more than the perception that someone else would buy it at a higher price. It's great while it lasts, but it never lasts forever.
If you are still playing the game the way it was played last fall, you probably bought i2 (ITWO) or FreeMarkets (FMKT) Tuesday afternoon, because a B2B rally one day used to produce a gap higher the next morning. That was then, this is now. Both stocks barely touched positive territory early and then headed straight lower from there.
The New Math
In this zero-sum market, there are two strategies worth pursuing, one macro and one micro.
On the macro front, there is the range-trade. The broad range on the Nasdaq extends roughly 1,000 points from the 3,300-3,400 area on the downside to about 4,300-4,400 on the upside. Buy the low end of the range and (as we have seen this week) sell the high end.
On the micro front, traders have to look for short-term momentum opportunities, and you generally have to be in before they start to truly benefit. Unlike last year, when the momentum would stay with a stock or sector for months, the momentum only hangs around for a few days or maybe a week this year.
Recent examples have been the B2B rally last week and early this week, and the e-tail rally on Wednesday. Chasing these moves was not wise, so instead it has become critical to have the foresight to identify the move in advance. And instead of looking for a business that is fundamentally strong and expecting the stock to follow, the momentum moves are often coming from beaten down sectors such as B2B and B2C, where there are large short positions and thus the potential for brief short squeezes. (Check out Damon Southward's recent Trader's Edge articles on Evoke (EVOK) and Ashford.com (ASFD) to get a sense of how to identify good candidates.)
Time Is the Cure
Surely some readers will protest that certain sectors with strong fundamental underpinnings will see lasting momentum, but we have our doubts. If ever there was a sector with strong underpinnings, it is fiber optics. Demand for optical equipment is booming. But look at the stocks -- much of the sector has been in a range. Look at a list of the leaders in the group and you see that most are still well off the highs hit last spring. Here are a few relative to their 52-week highs: NT -13%, CSCO -22%, JDSU -24%, SCMR -34%, AVNX -45%, LU -51%.
The problem for optical stocks is the same problem for tech stocks generally: as good as the business might be, the valuations expect even better! Just as the Dow has been spending the last 16 months waiting for the business to catch up with the valuations, the Nasdaq is now doing the same. Investors as a group are letting time be the cure for excessive valuations rather than lower stock prices.
The result is the zero-sum game that we are now playing. There is still money to be made, but the rules have changed. Respecting the trading ranges for both the broad market and individual stocks and sectors is critical -- buy the bottom of these ranges and sell the top. And when choosing specific stocks and sectors, note that the momentum crowd has shifted
from picking the hottest sectors to picking the beaten-down sectors with large short positions; it's a sign of the times.
Greg Jones - gjones@briefing.com |
