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Tuesday, 27 July 2010

First, Protect Capital

by Randall W. Forsyth

Down 100 points one day, up 200 the next. Who can make sense of this stock market?

The answer that first sprang to mind was Louise Yamada, the long-time market maven whose shingle reads Louise Yamada Technical Research Advisors, LLC. Along with Alan Shaw, she was the heart and soul of Smith Barney's renowned technical research department until parent company Citigroup (NYSE: C - News) decided to shutter it early last decade.

"One day doesn't make a trend," she said of the Dow Jones Industrial Average's 201.77-point pop Thursday.

The stock market's pattern remains one of "distribution," which in the parlance of technical analysts means stocks are being moved, or distributed, from "strong hands" that have profits to "weak hands," the Johnny-come-latelies who want to jump on an advancing market's bandwagon. A distribution phase classically is a symptom of a market that is topping.

To confirm the uptrend has resumed would take the market to clear a number of hurdles, Yamada continues. That would mean topping the July high, which in DJIA terms translates to 10,370, and a push through its 200-day moving average at 10,460. In simple terms, passing those tests would mean the upward momentum has resumed after the second-quarter slide.

But, "we need more days like this," she says of Thursday's price action to confirm a renewed uptrend. Moreover, the volume continues to be more vigorous on days when the stock market falls than on days of big gains, such as Thursday.

That said, Yamada points to technology as an area of relative strength in the stock market. Not a unique observation admittedly, but one she first put forth three years ago. Since the dot-com bubble's bursting, tech spent years of treading water relative to the rest of the market before gaining relative strength starting in 2007.

Of course, some "old" technology names such as Microsoft (Nasdaq: MSFT - News) remain mired in the mid-20s and getting cheaper all the time relative to its earnings and hoard of cash on its balance sheet. Indeed, Microsoft failed to rise after hours despite reporting robust earnings late Thursday. To be fair, the 2.9% pop during the regular session could have anticipated the strong results.

At the bottom of Yamada's list are the financials. As long as tech had to wander in the wilderness after the dot-com collapse, so are the financials likely to languish, she says. The financial-regulation reform legislation signed into law Wednesday is unlikely to hasten the group's return to leadership.

As for other market sectors, Yamada notes that Treasury yields such as the two-year notes have fallen to historic lows, touching a miniscule 0.56%--which could ultimately lead to an ultimate downside target of 0.40%-0.50%, she writes in her latest note to clients.

As for the benchmark 10-year Treasury note, she says the breakdown in the yield points to an ultimate target of 2.45%. a good deal below Thursday's 2.94%.

But Yamada calls the 30-year bond as the "canary in the coal" mine in an interview. While it has broken through 4%--at 3.96%, up from its recent low of 3.89% as a result of of its sharp price drop Thursday in reaction to stocks' rally—it has failed to set a new low on this move lower. And so, the long bond may be warning that the slide in Treasury yield lasts only as long as the flight to quality continues.

So many cross currents, so little time to sort them out. Yamada imparts invaluable wisdom to deal with them.

There are two kinds of losses an investor can suffer: a loss of opportunity or the loss of capital. There always will be future opportunities. But if you've lost the capital, you won't be able to take advantage of them.

The answer is obvious in these uncertain times: protect capital.

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