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Sunday, May 02, 2004
Market Recap
The grim reaper finally showed up on Wall Street on Friday and sunk the NASDAQ below its 200 SMA. I have been expecting this drop to the 200 SMA for a couple of months now. What I did not expect was for it to drop below the 200 SMA on the first attempt.
I was expecting to see a bounce when the NASDAQ touched the 200 SMA followed by a big rally shortly afterwards. However, this did not happen. As the market update Alert Friday afternoon indicated, when a stock or an index does not reverse sharply after touching a key support level, there is a high possibility of a failure. (See the last 3 Alerts for April in the alert index on the website). I could tell by the lack of any serious buying on Friday that we would not see rally and may see a cave in and a close below the 200 SMA. This is exactly how the market action played out, and it is not what the bulls wanted to see.
The NASDAQ is extremely over sold and needs to bounce soon, but due to the negative tone and close of the markets, I have added many short candidates to our Bulletin's Watch List. I would not short heavily at this point, but it is a good idea to be ready in the short term in case of a dead cat bounce (should we get one). I say “in the short term” because, as you will see in the charts tonight, all is not lost. Do not give up on our raging bull just yet. He has not left the party; he is just passed out in the back room.
Longer Term Charts
I have some two year charts of the NASDAQ, Dow and Russell (small cap) tonight. All is not lost when you view these longer term charts. Although none of these charts look good on a 3 month daily interval, they look a whole lot better if you view them from a longer term interval. The daily charts are a micro view of what is happening. The weekly charts are the macro view - what is happening longer term. Daily charts are excellent for short term trading. However, they tend to give us tunnel vision because we can not see the big picture using them.
Dividends
Since it may be a time to get defensive, I thought it may be a good time to talk about dividends. A dividend is essentially a payment, typically in the form of cash, to the shareholders on record. Lately, dividends have received a lot of press, because the government has reduced the tax burden on dividend payments.
When companies generate a lot of cash, they will often set a dividend payment that is paid out on a quarterly basis. This dividend is what attracts many investors to particular companies. Dividends also tend to keep money tied up in particular stocks. People like “free money” and they will hang on to shares in a company no matter which way the stock is headed. They can not pass up the handout each quarter.
Value investors refer to the dividend rate as the “yield” on a stock. One of the investment strategies I have used was to seek out the cheapest stock that is paying the highest yield. The strategy is that eventually the price of the stock will increase in relation to its yield. It is also nice to be receiving a payment in the form of a dividend while waiting for that price increase. Keep in mind that I have not used this strategy since becoming a short term trader. However, it may be a strategy to employ in our long term portfolio.
With the recent tax law change on dividend payments, many companies are using this as a way to load up their pockets. Unfortunately, most investors fail to see that these companies are reaping the benefits at the cost of shareholder value. More and more companies are declaring a one time extra dividend. These are in the form of cash, and they are typically a huge amount in relation to any quarterly dividend. Some companies have been handing out $5 or even $10 a share! Now, that would be great if you able to keep the value of the stock that you paid for it.
What many investors do not realize is that these extra dividends basically take the money right out of the stock price. If a stock is trading at $20 a share, and an extra dividend is declared at $5, the price of the stock will drop to $15. Why? Because the company is devaluing their own shares and taking that money in the form of cash.
Corporations pay taxes when they record profits, and the average tax rate on those profits is 35%. If they take those profits and pass them on to shareholders in the form of dividends, the max tax rate is now at 15%. It used to be that people would hold stocks for the long term and save taxes because the long term rate was about half of what the corporate tax rate is but now, you can get the cash out of the stock in the form of a dividend without the tax consequences.
Many investors will make the false assumption that buying a stock that is about to pay a dividend is a good thing, and they will completely ignore the chart or the fundamentals of the company. They want the free handout but get burned when the stock price falls and the dividend they received is wiped out by the loss is stock value. Sure they have the cash but they also have a tax bill now for collecting the dividend.
Here is a secret I will let you in on that I think is worth a year's value of the service alone. I have used this strategy before and it has worked well. The first step is to do some research to determine which companies pay the highest yield. Next, find out the X- dividend date and buy the stock about two weeks before the X-dividend date. Stocks will very rarely sell off and many will run up the week prior to the dividend. Stay in the stock long enough qualify for the dividend. The day after the dividend is issued, sell the stock and reverse your position (sell short).
The strategy is to jump in, collect the handout, and then jump right back out without getting caught in the sell off after the dividend is paid. The stock normally sells off after the X-dividend date. I do not use this strategy anymore, because I do not have the time to conduct research required. The moral of the story is to watch out for dividends in a bear market, it is a great way to earn some extra cash.
As always, thank-you for your support past, present and future! Have a great night everyone; we will see you all Tomorrow evening.
OTC BB Watch List
- DSNY
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