Trends Change, Markets Change, Are You Keeping Up?

Daily State of the Markets
Friday, January 18, 2013

Good morning. On days like Thursday, it can be a challenge to put away the fear and embrace the new bull market highs. It can be hard to forget about the upcoming debt/budget battle and just jump on the bull bandwagon. It can be hard to recognize that the housing market may not continue to be a drag on the economy or that Europe isn’t in the process of imploding. And it can be difficult to admit that the U.S. economy isn’t heading toward recession and/or that corporate profits aren’t too bad. But if you are an investor with an open mind, you had to do all of the above on Thursday.

Not only did the Housing Starts number surge 12.1% in December, which was well above the expectations, the latest report on jobless claims came in below consensus, which is a good thing. And then we got word that the Republicans might not be averse to raising the debt ceiling for a bit. So, before you could figure out whether or not seasonal adjustments had played a major role in the Initial Claims for Unemployment Insurance report (they did), stocks started off to the upside on Thursday. And while the bears did try to make a game of it at times, ultimately the bulls ruled the day.

In the process, the S&P 500 broke out of the recent tight trading range and made a new high for the almost four-year old bull market. And don’t look now fans, but the Smallcaps stepped out to a new all-time high, as did the Midcaps, which have really been on a roll of late.

Although their argument lacked conviction at the close yesterday, the spokesman for the bear camp suggested that the DJIA has not confirmed the move and thus, the venerable index is likely to struggle with resistance. But, given that the Dow is just 14 points away from the Promised Land, unless the bears can come roaring back on Friday morning, I think we can dismiss this worry. Oh, and by the way, the Dow Transports have been rockin’ to new highs on a daily basis now for the past couple of weeks. So, even the old school Dow Theory folks may have to turn bullish if the Dow can tack on a few more points soon.

Yes, it is true that this is an options expiration week and as such, there could have been some shenanigans going on in the indices yesterday – especially into the close. And yes, it is also true that short-covering may have been a factor as the S&P moved past the intraday high on 9/14 early in the day. And of course, I will admit that there certainly could have been some algo-induced trend-following activity at work on Thursday. But the bottom line is that from a technical perspective, a breakout is a breakout as there are no “ya, but’s” allowed in technical analysis.

I guess we also need to recognize that stocks remain overbought and that sentiment is starting to become a little too optimistic. And I will acknowledge that this may not be the best rally in the history of the stock market. But my point this morning is that the trend is up and that’s all I really care about.

You see, the money one earns from a stock market rally that may have some flaws spends just as well as the money earned from a really robust rally. Remember, in this game you have to play the hand that is dealt to you – not the one you’d like to have. So, when stocks are rallying, my job is to keep my clients on the right side of that trend.

Too many investors fall victim to the idea that stocks must act a certain way in order for you to make money in the market. While it may be true that lower quality rallies may be accompanied by higher risk factors, this doesn’t mean we need to sit on the sidelines with our hands in our pockets. And this most definitely doesn’t mean that we should start shorting the market just because stocks are overbought.

I know I’ve said this a time or two over the years, but too many investors wind up fighting the last war – or in this case – playing for the last big market move. Too many investors don’t want to get fooled again so they wind playing for the last cycle instead of the cycle in front of them.

Remember, cycles change and market environments change – ALL THE TIME! Thus, as investors (and especially as investors that focus on managing risk) it is our job to change with them. In short, the great bear market of 2008 ended nearly 4 years ago and there have been great opportunities for profit since then. But unfortunately too many folks continue to expect stocks to dive 35% again in the near future.

Spoiler alert: I am once again going to “talk my book” for a moment here (but I will promise to keep it brief). The problem with this game is that it is rarely easy to tell what to do in advance. Only with the benefit of 20/20 hindsight can investors tell what they “should” have done (remember, in my shop we are not allowed to use the words should, could, or would when talking about the market). And it is for this reason that I lean on market models to tell me when the odds favor the bulls, the bears, or neither team.

Sorry for the pitch about using models to guide your investing decisions again. But after more than 25 years in the business of managing other people’s money, I’ve found that this is what works best for me.

Getting back to the market, I frankly have no idea if the current rally will continue or not. In this hypersensitive, algo-driven environment things can turn on a dime. But for now at least, my models tell me to give the bulls the benefit of any doubt for a while longer.

Turning to this morning… Asian stocks rallied strongly on the back of improved economic data in China as well as expectations for an open-ended QE program in Japan which would target an inflation rate of 2.0%. However, the mood across the pond is less than upbeat while Intel’s earnings are a drag on the NASDAQ and even GE’s better-than expected earnings have not moved the U.S. futures far from the unchanged level.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

Major Foreign Markets:
– Shanghai: +1.40%
– Hong Kong: +1.12%
– Japan: +2.86%
– France: -0.03%
– Germany: -0.21%
– Italy: -0.47%
– Spain: +0.04%
– London: +0.39%

Crude Oil Futures:

-$0.19 to $95.30 !========>!========>