Storm Clouds or Fog Waiting to Lift?

  • Posted by
  • on October 29th, 2010

It’s even worse than it appears but, it’s alright.”  Grateful Dead

We’ve had a string of overlapping days, with breadth falling off amidst a hot potato of rotating momentum stocks.  This sets the stage for something different than what we’ve experienced since September 1, which was a generally rising tide up.  Dips have been bought, rallies have been sold, while the leadership mix has rotated even inside each sector.

On October 13, 85% of the stocks in my universe closed above their 10 day moving average.  That number plunged to 35% on October 19.  For 7 days since, it has been magnetized to the 50-65% range, indicative of a market seeking balance.

Under the surface, however, we’ve seen explosive moves in a narrowing cross section of stocks.  To me, this indicates the presence of energy…the question is, are we seeing the last bursts of momentum or those fabled “green shoots”?

I’m honestly stumped, with as foggy a picture as I’ve seen in months.  I own both longs and shorts, and up until Monday my longs led every bounce…the past few days have seen the opposite, as laggards have held lows and leaders have been unable to punch and hold highs.  The indices maintain a persistent uptrend, and longer-term charts are a thing of beauty.  This tells me the resolution is more likely to come on the upside, but only after a re-emergence of breadth.  It took a few early lessons to learn that relative weakness in breadth can mean relative strength in indices(see late 1994), and that can’t be forgotten.  A quick look at a devil’s advocate debate:

1) The bond selloff indicates a lower deflationary threat, yet stock bulls haven’t seized control

2) The fraction of stocks rallying on a swing basis has shrunk from 3/4 to 1/2, but rotation has kept the indices steady

3) Financials are under obvious public pressure, but a technical freefall has been avoided

4) Rallies to new highs have been thwarted, but selloffs have been contained to hours at most

I’ve wasted your time with the obvious…what is the plan?  For me, it is to throttle down and assume a continued negative feedback loop.  I don’t see a need for heavy positioning, as we are heading into a set of major news events with QE2 and the elections next week.

Strategically, though, I am preparing for a much wider range of outcomes.  We are lingering around under the spring 2010 highs after expending a lot of energy to get there.  I believe the next move will be substantial, either shocking many with a burst through those highs or a failure and test of the summer lows.  The fact that we have a rising 20 day MA above a rising 50 day MA above a flat to rising 200 day MA has me leaning towards the bullish resolution.  My favorite breadth indicator has yet to flash a danger signal.

But this is a terrible location to make that bet.  Until we’re able to break and hold the spring highs, sellers can lean on the market without worry.  And if a breakout doesn’t come(or worse, comes and fails), we’re set for a “fast moves from false moves” correction to the lower end of the 2010 range.  High risk, high reward…again, not the time for aggression.  In the meantime, day traders and long-term investors can continue to pick off opportunities at the expense of swing players overanticipating a move.

Smaller positions and a much wider range of scenario planning…that’s my plan of attack.  Chances are, the first move out of this recent “12 day and growing” range will be a headfake.  I’ll keep dissecting the data, and when multiple timeframes line up I’ll act with confidence.  Until then, I’ll have “Every silver lining’s got a touch of grey” ringing in my head.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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