Half a Loaf

The NASDAQ broke out to new recovery highs yesterday and did so with rather convincing price action. Volume, unfortunately, was another story. There was little participation in the move. While we feel confident in asserting it is because of the time of year we caution against making an allowance for this type of questionable behavior. Our experience is that volume shows up when it feels compelled to do so no matter how many people are on vacation.

If there was any day during this holiday period where we would expect higher volume it would have been Monday. There are only two full trading days remaining this week and each successive day is likely to see progressively less volume as we get closer to Christmas. As for next week you are more likely to get a pulse on a 106 year old man than in the market.

Unless volume makes an appearance we believe you should trade this new rally leg with caution. What does caution mean? Should you cut and run at every hint of an intraday correction. No. But you should likely approach this move as a swing trader would, looking to take profits after a measured move out of a base or at a sign of exhaustion. Remember, though, that this is a bullish time of year and it appears good profits can be made in the closing days of 2009.

We have said for weeks that we were looking for a final market burst higher before a correction would take hold. Today’s move validates our thesis. New highs on light volume in an extended rally could well signal the first intermediate term correction of the bull market might begin next month.

But for now there’s sufficient rum in the market egg nog to make the holiday season that much brighter.

Naughty or Nice, Santa Could Visit the Markets This Week

Week after week we continue to maintain a bullish bias. Week after week the market looks at times ready to break down only to threaten to break higher on the climactic leg we expect for the rally.

With Christmas on Friday and many traders away from their desks it would seem unlikely that the market would stage a high volume move at this time. Asian markets that suddenly threaten corrections could also keep it in check. The Shanghai Composite has broken back below its 50 MA once again after some ugly selling late last week. It has now been over four months since this bourse, the international leader of the current rally, has made a new high. And Hong Kong’s Hang Seng has put in place a threatening looking top. Should these indices and others follow through to the downside this action could eventually put our own markets into correction, given that they have been poor stepchildren to the performance of international stock exchanges this year, clear followers and not leaders.

But we still believe the best prospects for making money continue to be made on the long side and that investors will fare best by preparing to take advantage of a robust resumption of the rally, no matter how unlikely.

We have cited the emergence of new leadership in prior columns. Indeed the Philadelphia Semiconductor Index ($SOX) moved last week to fresh recovery highs. And we have noted that smaller caps have staged successful break outs as the small and mid cap indices, which had lagged until recently, have rebounded smartly. Further, many large liquid leaders that had previously led the rally continue to base and are well positioned to emerge. Apple (AAPL) has put in a mature flat base (we have recently recommended watching for entry on our sister site) while Amazon (AMZN) has about pulled back to its 50 MA, an area that should intrigue most traders. On any resumed rally these big caps could help expand breadth and move the broad indices higher.

The bounce in the dollar has forced the volatile correction of hard assets we foresaw, but that might be ending now. The dollar ran into significant resistance on Friday and formed a reversal bar. Conversely Thursday the price of gold broke down below its previous lows and its uptrend looked ominous. But Friday saw good support and suggests if gold is not yet set to rally again it might well have put in its lows. These are important developments because a declining dollar has been matched by a rising stock market since March. A resumption of trends might well be at hand.

Also encouraging are the weekly charts of the major indices themselves. A friend of ours recently pointed out there has been little accumulation in either the S&P 500 or the NASDAQ over the last couple of months, and indeed he is correct. But the NASDAQ continues to trade near its highs, closing Friday at a fresh recovery high and the S&P 500 has now formed a highly bullish 3 Weeks Tight (3WT) pattern on top of a previous 3WT pattern, suggesting Santa could indeed be coming to town.

The Extended Period Extends

Bulls got their Christmas wish today as the Fed stood just about completely pat, as we expected they would. They reconfirmed that they will sunset some liquidity programs, but these plans were telegraphed to the market months ago. The wind down of some of these programs is actually the first step in the removal of accommodation but thus far the Fed has not given any hints about when they will go further.

The market closed poorly but reaction immediately after Fed announcements is often best ignored. The market usually takes at least overnight to digest the Fed action and accompanying statement. Without anything significantly different we believe it will be treated as a non-event.

What we’re most impressed with is that the market, while still in basing mode, has actually already subtly started another leg higher. New leadership has started to assert itself, which often happens in advance of the market itself breaking authoritatively to new highs.

HMO’s have moved nicely higher as it has become apparent that whatever healthcare plan comes out of congress will avoid any serious damage to their business models. While these stocks could lead we’re more taken with the emergence of cyclical groups like chips and airlines.

Indeed the Philadelphia Semiconductor Index ($SOX) and the Dow Transports ($DJIT) have already moved to fresh recovery highs. This is significant because these groups tend to outperform early in an economic recovery. In other words, the market is increasingly convinced that the recovery is real. We’ve repeatedly discussed the likelihood of this paradigm shift and we’re seeing it confirmed in real time as investors seek out those sectors that are likely to benefit as the economy continues to improve.

With new leadership beginning to assert itself, and with smaller cap stocks starting to outperform again after lagging badly during the recent market basing period, we continue to believe it is only a matter of time before the market begins another leg higher.

Not Ready

The market stalled at resistance once again today. Technically it seems destined to retreat from its highs.

Market commentators are crediting hot PPI numbers and a dour “pre-earnings” comment from GE for today’s poor tone. But the PPI numbers were released before the market opened and the session saw the NASDAQ and other indices rally to fresh recovery highs. And besides, the hotter PPI numbers were not much more than a reversal of the cooler numbers witnessed just last month. A trend has certainly not been established. As for GE, this is a company that has struggled throughout the financial crisis and as a turnaround strategy intends to focus on government incentivized businesses. If this was once a bellwether it is now captained by executives that seem clueless in how to weather this storm.

No, the market went down today because it simply wasn’t ready to move higher. Especially in front of an FOMC statement on interest rates to be released tomorrow afternoon. Speculation abounds as to whether the Fed will alter policy or the accompanying statement, but this is a Fed that has been cautious to a fault in not surprising the market. We doubt they will change their statement about rates being held at low levels “for an extended period” without amply telegraphing it in advance. Thus far there hasn’t even been a hint.

While market prices are likely to continue to “fluctuate,” as J P Morgan once famously said, we still believe another leg higher remains a likely resolution. Provided the Fed is not ready to remove accommodation, and we clearly don’t believe they are, they have provided sufficient stimulus to the economy to induce solid growth. We believe the market will rally into what it anticipates to be “better than expected” Q4 earnings.

In the meantime we are encouraged that stocks have held up in the face of an aggressive move higher by the U S Dollar that does not seem anywhere near over. With each day that passes the link between the two asset classes, that have been inversely linked all year long, appears to be weakening. Stocks and the dollar rallying together would be a heartening turn of events and a sign that we are awakening from what has been a national nightmare.

Market Indices Hold Near Highs, Defying Correction Expectations

There has been subtle distribution across the indices. While price has held up internals have not been as favorable. But we remain in a consolidative phase. And with indices of all varieties holding near their recovery highs the sentiment of traders we speak to remains incredibly bearish. We read this as a positive sign.

We also read as positive the market’s ability to hold while gold and the dollar enter what for now appear to be counter trend moves. All year stocks had marched higher as the dollar’s value eroded. Now with the US Dollar Index moving above its 50 MA for the first time since April and technically poised to go higher, stocks are simply pausing, not aggressively retreating as one would expect given the inverse correlation between these asset classes.

Meantime the aggressive advance on the stock indices since March has signaled many of the events that are unfolding today: signs of a recovering economy and a banking system that, while far from healthy, is far from the insolvency that was threatened just a year ago. Again, one would expect stocks to sell this news when it occurs, but it has yet to happen.

Not long ago we surmised that there has been a paradigm shift in the market. That it is now focused on returned growth and the prospects of sharply accelerating earnings in the year ahead. Every day the indices continue to quietly base adds credence to that assertion. And a solid break out to new highs and another leg higher would confirm it.

Most of our stock suggestions on our sister blog have been mired in neutral these past few weeks, not triggering or stopping out as the market chops up position traders. But we continue to have suggestions for stocks that we think have the ability to ignite on another leg higher and we invite you to review our ideas.

If at First You Don’t Succeed

The indices remain paralyzed in a holding pattern. Most traders remain convinced that a significant correction is only a matter of time. And investors have certainly given cautious clues, bidding up utilities in a clear flight to safety and yield.

And if the indices haven’t broken down the argument can be made that investors would prefer to take profits in early January, postponing an appointment with the tax man into next year. They certainly appear to be in no mood to take further chances before they can close the books on what has been a most profitable year for many.

Further, the Three Weeks Tight pattern on the S&P 500 we detailed in our last column has broken down with price undercutting last week’s low in today’s trading.

And yet we still believe the market needs to be given the benefit of the doubt. The index dailies yield setups that call for higher prices. Failure here could be devastating for the market uptrend but most leading stocks continue to hold up just fine in their price structures.

In fact our bellwether, Apple (AAPL), which had recently broken below its 50 MA on volume, bounced back with a vengeance. Whether this is a temporary reprieve remains to be seen. In the meantime we can only know what the market is telling us, which is that big money is continuing to support what has been the bull market’s most important institutional stock.

The Market Will Head Higher

There. We said it.

For three days in a row into the end of last week the major indices flirted with fresh highs and were beaten back. Friday’s gap up was sold off on such enormous volume that even we were convinced the uptrend would yield to its first significant correction.

But a funny thing happened on the way to the sell off. It was arrested.

The daily charts of the major indices, especially the Dow and the S&P 500, look ready to head lower. But pull up weeklies and read a different story.

Friday closes are important. They allow us to read the true intentions of institutional investors on weekly charts while turning down the “noise” of dailies. Leaving your money invested on a Friday means you have to endure two days of uncertainty before the markets will again allow you to adjust your appetite for risk. A handsome weekly close indicates big money is feeling fairly contented. And that’s just what we have with Friday’s close.

The chart of the S&P 500 shows a pattern familiar to all of O’Neil’s students: Three Weeks Tight (3WT). During an uptrend O’Neil preaches that three tight weekly closes in a row, where the closes are within 1% of each other, are bullish and that breakouts from this pattern are opportunities to add shares. While the index closed below the highs of the 3WT formation the advance on high volume is clear enough. And the index closed in the upper half of its range.

The NASDAQ has completed a corrective pattern that saw it sell off under its 10 MA weekly on volume at the end of October only to right itself, move back over the line, pull back to it in light volume and now break to fresh market closing highs on the highest volume in five weeks.

The catalyst for Friday’s wild action was the employment report, which took the market by considerable surprise with its positive implications. Real growth, not simply stimulus ephemera, appears to be in the making, and the market was ebullient.

Clearly the late morning sell off was due to concerns about The Fed likely ending its easing policies far earlier than anticipated given the change in perception about the economy. We have long said that we are of the opinion that the rally will conclude when the liquidity orgy is over. When investors started to sell the news in the late morning we weren’t surprised.

That they had second thoughts about doing so going into the close did surprise us. It is clearly bullish and an indication of a possible change of paradigm for the rally with liquidity no longer its raison d’etre but rather the certainty of resumed growth.

We witnessed violent sector rotation, which was responsible for the indices ending with gains. The commodity liquidity plays, led by gold and gold stocks, sold off hard. Meantime Small Caps surged over 2% as investors segued into growth oriented stocks that are most likely to benefit from resumed domestic growth and avoid the negative effects a reversing dollar will have on the bottom lines of larger cap companies. And transports and semis, traditional harbingers of growth, surged to new 52 week closing highs.

How these trends play out over the coming week will be crucial. Recently we suggested it was time to take some profits in gold to make sitting through an inevitable correction easier. The trade in gold has been so one sided that when it broke it did so with a large gap down from all time highs. We predicted this is likely to be a volatile correction and the inevitable questions about whether this is a correction or change in trend will emerge should severe selling continue.

Whether the moves in gold and the dollar are corrections or changes in trend will dictate where the opportunities will be in the weeks ahead. We expect a continuation of the rotation we saw on Friday, but as always will follow the market assiduously for clues.

The Market is Set for Weakness to Follow Through

Yesterday we advised that failed new highs in the indices could lead to some selling pressure and we saw that into the close today. Whether this selling was protective in nature in front of tomorrow’s employment report or the response to other stimulus doesn’t matter. Clearly the market is braced for bad news.

We saw signs into the close that selling could be a multi-day affair. The stock that is the clear current leader, Amazon.com (AMZN) staged a reversal on volume. While not ominous this stock hasn’t touched its 20 MA since it launched its break out October 23^rd. A betting man would lay odds it has such a rendezvous in its future.

But until we see serious selling and the thinning leadership cracking we will maintain that holding profitable existing positions and searching for proper entry in correcting leadership stocks remains the best course.

In the meantime we have posted on our politics blog, a rare event in itself, usually inspired when our passion is stirred on one burning issue or another. Today’s entry is a defense of our beleaguered Fed chairman. We invite readers to have a look.

Stay the Course

We are rarely at a loss for words but we have to admit when we’ve been bettered. The current market has simply stymied us. The markets have been in a trading range for two months and bearish divergences abound. It is difficult to come to market on a daily basis and find a unique way of saying the same thing. Nevertheless we will try.

Stay the course.

This is likely unwelcome advice for frustrated investors who may have exited the market weeks ago and seek reentry at the most propitious point. The indices have broken down only to recover; and then broken out, as they did today, only to duck back into their bases.

But while the break outs across the markets universally failed today to us there was nothing ominous about the action. Volume was light and the bears made little headway after the stall. That doesn’t mean today’s action won’t have consequences. Failed new highs can often yield to an increase in selling pressure. But nothing about today’s action suggests another attempt into new high ground isn’t in the near term future for the indices.

On the positive side the small cap indices have led the market the last two days. They have lagged badly during the current consolidation and have put in lower highs, setting up a threatening pattern. The aggressive gains are welcome. And the world leading Shanghai Composite, which took a beating last week, first on news that banks would have to raise their reserve ratios (potentially threatening lending activity that has driven the stimulus program) and then on the Dubai debt crisis, have rebounded smartly and on good volume.

We’d like to present a chart for your study:

You may be forgiven if at first glance you think this is the current S&P 500. After all, it does have some familiar attributes: a sharp rally that began in March; an aggressive uptrend throughout most of the year; and a tiring rally during the fall in which the index made little headway.

But it is not today’s S&P 500. It is the NASDAQ Comp from 2003. Samuel Clemens would be pleased at yet another example of how history may not repeat but often rhymes.

We now present another chart:

This is the same chart only with the time frame extended into January 2004. The market topped after that profitable little burst and we endured a rather choppy 2005. But if history doesn’t repeat, it suggests you should stay the course.

Of course there is no guarantee that the uptrend will deliver another leg up. Until the markets make a pronounced move higher we would not be aggressive in allocating new funds, opting only for situations that are clearly bullish by price and volume action and at proper buy points. Entries without catalysts in the current environment are invitations to endure choppy trading, make little headway and take small, but frustrating, losses.

An excellent example of what we seek is Potash (POT), which we profile on our sister blog.