Massive Opportunity In 2012, But Then Look Out Below

There are several long-term cross currents in the current U.S. stock market environment. On the negative side, measures of volume and participation of “smart-money” have been woefully lacking since the October 2011 bottom, and really since the March 2009 bottom. In his weekly column in, technical analyst Robert McCurtain maintains close tabs on several market indicators including cumulative volume, most actives advance/decline line, and the call/put dollar value flow line. His indicators do not support the long-term sustainability of these market levels and suggest some future massive bear market.

Shorter-term, there is no arguing the fact the market needs a rest after the S&P 500 index has run nearly straight up 18% from its mid-December bottom. The number of stocks participating in the rally has fallen off since early February, clearly evident in the performance of the broad Russell 2000 index verses the S&P 100 index.

Investor’s Business Daily notes the rally is under pressure following a recent cluster of high volume down days and stalling days in the major averages. From a fundamental standpoint, short-term weakness is also supported by recent declines in the Citigroup Economic Surprise Index, which shows economists became too optimistic into January and February and are now tempering their GDP growth views. A decline in this index often precedes a decline in the market. On a short-term basis, traders are well-advised to take some profits off the table at this juncture.

On the long-term positive side, four fundamental items support robust prices: the U.S. treasury yield curve is positive, the U.S. leading indicators index is sloping upwards, equity prices are somewhat undervalued looking at historic earnings multiples of the S&P500 and deeply undervalued using the Fed Model, and the availability of cheap credit is improving (see my recent blog “Is A Bear Market Around The Corner?“). Looking at sector leadership, the aggressive sectors — technology (XLK), consumer discretionary (XLY), and financial (XLF) — are leading the market higher and show little sign of rolling over.  The chart below illustrates the strength in these sectors versus the S&P500. This is a sign of market strength and trend sustainability.

The early 1950s also offer some precedent: when long-dated Treasury yields started to rise in that era, stocks surged as investors fled falling bond prices for equities. The same may happen today.

While a focus on the chart behavior of individual securities leads to trading success, my current thinking is that aggressive positioning in new plays could pay off once the market consolidates its recent 14-week run. When the general positive factors discussed above degenerate (perhaps by the end 2012), I’d expect another generational bear market. After all, the federal reserve is out of bullets — they cannot lower short-term rates any further to help in the next (and inevitable) economic downturn.


About jstradingnotes

I spend a lot of time analyzing the economy and securities. The effort has enabled me to generate multi-thousand percent returns on my trading capital over the past twelve years. The next few years offer an incredible opportunity to take outsized gains from the markets. Large structural imbalances in the major western economies will result in enormous market volatility as the imbalances get resolved, offering generational money-making opportunities. The major imbalances are excessive sovereign debt, crazy risk concentration in major banks, and enormous derivative exposure in the financial sector. A systemic shock can easily create a default cascade through the financial system where one failure precipitates another and another and so on. Central banks are very aware of the risks, and they are filling the financial system with liquidity by printing new money, risking massive inflation in a few short years for the United States and Europe. China has 2-3 trillion in dollar exposure, and they would like to have far less for fear of continued currency devaluation (they've lost billions holding dollars as the value erodes). As the size of their holdings prevent them from rapidly liquidating their dollar assets (which includes U.S. treasuries), they are instead spending their dollars on resources (copper mines, rare earth metal mines, oil wells, etc.). Lately they have been accumulating gold assets, perhaps with a view to making the Renminbi convertible into gold and displacing the U.S. dollar as the international reserve currency. Their gold buying is enormous and presents an easy investment thesis: ride the Chinese horse and buy gold and gold stocks. In this blog, I'd like to share some of my trading ideas and insights on the markets as these exciting times unfold.
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