The Rotation Game

Daily State of the Markets 
Wednesday Morning – January 26, 2011  

If you find yourself wondering what to make of the current stock market action, you are probably not alone. The leaders have been smacked around pretty good lately while the old guard blue chippers have suddenly come to life. In addition, the gold rush appears to have ended, networkers are so last year, commodities are on the run, the dollar is in decline, and yet the fear of inflation (in the emerging markets, that is) is cited daily as a reason for market weakness.

Speaking of market weakness, the areas that are weak seem to be very weak while the Dow and S&P 500 finished Tuesday’s session within spitting distance of new highs for the current bull market cycle. So, to say there is a little head scratching going on is a bit of an understatement. To which, I’d like to say, welcome to the rotation game.

Up until very recently, the stock market’s modus operandi was pretty easy to understand. You bought and then you bought some more each and every time any of the leaders took a dip. There were no worries about the height of the trees or the level of the sky. No, buying the dips of the high fliers has been the name of the game from the moment the words quantitative easing came out of Ben Bernanke’s mouth.

However, this one-decision market, which saw everyone buying the same tech, commodity, and industrial issues, eventually produced a boatload of charts that had “gone parabolic.” And regardless of forward-looking P/E’s, upbeat earnings guidance, buybacks, rumors, or Apple’s next big thing, everyone who has ever drawn a trendline (either with a mouse or the old fashioned way, with a sharp pencil and a ruler) knows that parabolic chart patterns tend to end badly.

So, what appears to be happening is a rousing rendition of the rotation game. Instead of a market pullback due to some macro event, sovereign debt news, or worry about the economy double dipping, we’re seeing the fast-money types moving money from one area to another. F5 Networks (or just about any company with the word ‘network’ in its name) is out and the Wal-Mart’s and Home Depot’s are in. This produces both the sudden downdrafts as well as the nastiness we’ve seen recently in some companies and the refusal to yield that is occurring daily in the blue chip averages.

The intraday whoosh down that seems to occur all too often lately is likely a result of programs tied to the stocks being dumped en masse. Then as the players of the current game begin to reposition capital in the names you’ve come to ignore, the computers take the baskets, the futures, and the ETF’s higher. The end result is a relatively ugly picture over on the Russell and a Dow chart that a bull just has to love.

So, if you find yourself wondering when your Aruba Networks (ARUN), your Blue Coat Systems (BCSI), or your Emulex (ELX) shares are going to stop diving on a daily basis, you’d best figure out when the hedgies will grow tired of buying the old-school names such as Cisco (CSCO), GE (GE), The Travelers (TRV), and Home Depot (HD). Until then, it looks like it is “game on” in the rotation game.

Turning to this morning… Futures are pointing toward a modestly higher open so far on the back of improving sentiment regarding the prospects of a global recovery. The President’s State of the Union address is being widely credited for helping improve the mood based on the prospects of reduced corporate income taxes and a pledge to freeze domestic spending.

Later today, the Fed will be in focus with the release of their statement slated for 2:15pm.

On the Economic front… We don’t have any data to review before the opening bell. However, we will ge the report on December New Home Sales at 10:00 am eastern.

Thought for the day: Remember to think positive today…

Pre-Game Indicators

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

• Major Foreign Markets:
  • Australia: +0.43%
  • Shanghai: +1.17%
  • Hong Kong: +0.23%
  • Japan: -0.60%
  • France: +1.13%
  • Germany: +1.14%
  • London: +1.25%

   

• Crude Oil Futures: +$0.61 to $86.80
• Gold: +$1.40 to $1333.70
• Dollar: higher against the Yen, Pound and Euro
• 10-Year Bond Yield: Currently trading at 3.387%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: +4.92
  • Dow Jones Industrial Average: +12
  • NASDAQ Composite: +6.22

Wall Street Research Summary

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