Late Money Needs to be Cautious

We have completed the first hour of today’s trading and volume on the NASDAQ, which is the leading index and thus the one we heed for market clues, is the strongest for a first hour in over a month. It’s even stronger than what we saw on 7/15, the day the bullish move finally gained steam. And therein lays a cautionary sign.

When a rally begins on a burst of volume, such as we saw on 7/15, this is a sign of likely higher prices ahead. The volume provides the fuel to move higher.

But when you see even higher volume on a rally that is already extended it’s time to exercise some prudence.

This is a sign that the rally is finally registering with retail investors and laggard investment managers. They are literally throwing money at the market in a desperate attempt to not be left behind.

Such a move usually signals an imminent end to the upward momentum.

This does not mean that you should look to short a coming correction. We have mentioned on this page that we are bullish over the intermediate term and that corrections in the early stages of powerful new rallies can often last just one day.

It is a call to be less aggressive; to hesitate in initiating new positions and trim intelligently entered positions to bank some hard won profits. And await a likely pullback that will serve to scare the late comers and provide new entries for savvy investors who will buy from the panicked weak hands.

The Limits to Bullishness

We remain very bullish on the market but aggressive investors need to be in the right stocks. Clearly, P F Chang’s China Bistro (PFCB) is not one of them.

This is not to deride the company. We’ve followed their conference calls this year and have been impressed. Under difficult conditions the company has managed to churn out impressive profits. This is a very well run company.

To recap, in Q1 the company posted a 23c beat. Today they announced they beat by a dime in Q2. They have posted 37% and 24% year over year EPS increases. This kind of earnings acceleration often accompanies an uptrending stock chart.

But not in this case.

These big beats have been accompanied by flat sales. And the company reiterated today what they said last quarter; that sales would be anemic for the balance of this very challenging year.

The news last quarter was unexpected and gapped up the share price to 52 week highs. Anticipation that things might get better in spite of the company’s caution kept the stock in a tight trading range since. But the market has taken today’s news at face value. The beat was expected and flat sales, with the prospect of flat at best to come, will no longer be sufficient to award the company a 21 PE ratio.

This earnings season the market has been thrilled at evidence that things are on the mend. Improving corporate earnings are usually the earliest sign of economic revival. And those companies that have provided evidence that their market has bottomed and have visibility into a brighter future have seen their share prices rewarded.

But earnings quality is preeminent in the current market environment and growing earnings through cost cutting will only count for so much. Clearly, it won’t count for a higher stock price.

The Rally Proves its Mettle

Throughout the rally that started in March there was a lot of doubt about its viability. It seemed like a bear market rally, not for the least reason that it was led by very oversold stocks rather than those making 52 week highs.

Why are stocks making 52 week highs so important? Because they attest to growth, the key to a bull market. Stocks bouncing from badly oversold conditions cannot sustain a rally, they can only alleviate the oversold conditions preparing the way for even lower prices.

That’s why this new leg of the rally is so momentous. Throughout the rally the universe of all stocks (excluding closed end funds) making 52 week highs never got anywhere near 100. The single exception was the day last month of Russell rebalancing which caused a lot of volatility that, like Shakespeare’s actor strutting and fretting, ultimately came to naught.

But yesterday 120 stocks made 52 week highs. Keep your eye on this list. My money says it should expand and with it so should your appetite for stock market risk.

Mark Twain Didn't Trade Stocks

Samuel Clemens famously said, “History doesn’t repeat, but it often rhymes.” Clearly Mark Twain didn’t trade stocks.

Time and again when a market rally begins I hear the same thing from traders. “I can’t believe how strong the buying is. I can’t believe there is barely any retracement. Sellers have all but disappeared.”

After seeing this type of behavior in action a few times traders should get the message. This is why you need to be on board stocks that are best positioned for major advances when an uptrending market that has paused for a mild correction confirms a significant turn.

We got that turn last Monday and mentioned it on this page. It didn’t have to lead to a big move, but after undercutting the recent lows on the major indices and stubbornly refusing to go lower it paid to take longs in top performing stocks, many of which we profiled in our sister blog. They were low risk entries last week. Since that time many of them have wracked up attractive gains.

Are we due for a “correction.” If by a correction you mean a down day for stocks the answer is yes. But remember that early in a rally bad days tend to be isolated. This might sound familiar to those who follow my commentary on Briefing.com but you rarely get two down days in a row. Unless earnings reports of market moving companies become disastrous, and early results suggest they will not, look at a brief pullback whenever it comes as a buying opportunity.

Copper as a Leading Indicator/A Resumption of the Market Rally

ETF JJC essentially tracks copper futures. Copper, of course, is a key economic indicator given how essential it is in myriad industrial processes.

Since the market rally began in March the chart of JJC looks strikingly like that of the NASDAQ, which has been the leading major market index.

This morning JJC is gapping to fresh July highs, a move that could well take out the June highs which would represent a 52 week high.

The NASDAQ is gapping up as well but not as aggressively, remaining below its July highs for now.

You might consider JJC as a leading indicator for the NASDAQ, signaling a fresh uptrend phase to the market rally that appears to have begun on Monday.

Today's bullish market action is confirmed by first hour trading volume, which is the highest in nearly a month.

As for our previous post regarding a correcting market, it appears SYNA is more of an isolated event than a portent of the market. The stock continues to swoon on competitive concerns. We cited it as a proxy for several stocks that were failing to hold key support after important advances, which often presages a further market breakdown. The error here was in focusing on a narrow sampling. Today's moves in copper and the stock market are clearly broader and more trustworthy.

A Change in Market Direction

SYNA is a poster child for a shift in market sentiment. There’s nothing momentous about this company. It has a market cap just north of $1B making it a very small mid-cap. According to our software there are over 1300 publicly traded companies that are larger. But its trading activity makes it a “tell” for the current market.

SYNA began its uptrend late last year, well ahead of other stocks making it a relative strength outperformer. To its June peak it about trebled. Stocks in well defined uptrends such as this can usually be bought on the rather rare occasions when they touch their 50 MA’s, provided the market remains supportive.

And here we have the rub. SYNA pulled back on disinterested volume the last several days. Yesterday it settled just north of the 50 MA. Every institution interested in this stock certainly saw it last night, all set up as a “buying opportunity.” Only today nobody’s buying.

SYNA sliced below its 50 MA on volume almost from the opening bell. No one even made an attempt to defend the line. When you see stocks in well defined uptrends so blatantly fail to find support at typical areas of institutional interest it’s time to duck and cover.

The market will certainly bounce, but longs are countertrend now. You can’t expect the extent of a bounce out of a reversal formation that you would in an uptrend. Better yet, rallies are shorting opportunities. Earnings season could change all of that, but it increasingly appears the market isn’t betting on it.