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Some Cautious Bull

Stock Market Trend: Market Resumes Upward Trend 

Is the economy progressing beyond its policy- and inventory-led surge toward persistent, demand-driven growth?
-- Dismal Science

Last week's action marks a pivotal point in the stock market cycle.  Both improving fundamentals and technicals have shifted the risk/reward ratio towards the long side, while IBD has officially called a resumption of an upward trend.

Fundamentally, as the above quotation from Dismal Science suggests, we are getting a surge in economic activity both from a business sector rebuilding inventories and from a massive fiscal and monetary stimulus.

Certainly, it is easy to see trouble ahead -- a potentially faltering consumer, a Greek tragedy in Europe, and a bubble bursting in China. However, at this juncture, market participants are discounting these risks and, as a forecaster and trader, it would be irresponsible of me to ignore the market’s collective judgment.

At this juncture, then, what the market is telling us is that the U.S. remains in the early stages of a recovery and this recovery is likely to continue to expand without significant inflationary pressures over the next several quarters. 

In moving my cash off the sidelines and into the market, I am using a blend of five strategies that includes sector rotation, geographical diversification, and straight up trend trading combined with a small cap biotech hedging strategy and a Soros-style macro currency play.

A sector investment strategy at this early stage of the cycle favors oil, energy, materials, and transportation.  I play these with sector ETFs such as DBO, XLE, XLB, and IYT – all are technically bullish.

Internationally, two of the strongest country ETFs are Australia (EWA) and Mexico (EWW).  I see Australia as a hat trick commodity, currency, and China play.  I believe Mexico will trade well because of the improving U.S. economy.

My favorite broad index play to trade the trend is the Russell 2000 – symbol IWM.  It is the strongest of the major U.S. indices right now from a technical perspective and has the most volatility.

I might add here that there is a lot of chatter on both CNBC and in the blogosphere about how gold is a great buy. Commentators point to the massive fiscal stimuli and easy money awash in the world and point to an inevitable inflation. Some commentators also point to what must be the inevitable decline of the dollar given America's budget and trade deficits and bloated Federal Reserve balance sheet.

I agree with all that, but good trades are a matter of timing. So I say stay away from buying gold for now and keep away until either inflationary pressures build or the dollar resumes its long term decline. 

In that same vein, although both sectors are showing bullish signs, stay away from homebuilding and consumer discretionary spending for just a bit longer to see if the consumer finally declares him or herself into the recovery.

Perhaps surprisingly, most of Asia remains relatively unattractive for now on a technical basis because of  question marks related to the tightening of Chinese fiscal and monetary policies.  So I am avoiding Asia exposure for now, except for Australia.

Finally, I continue to hold 20% of my portfolio in biotech (CHTP, DUSA, HALO, PBTH, SNMX) and continue to have a big macro bet on the Chinese yuan appreciating over the next 12 to 24 months. On my biotech holdings, this is the fourth part of my blended strategy approach to the markets.

In particular, I favor small-cap biotech for two reasons. First, small-cap biotech stocks are driven far more by the drug trial cycle than the business cycle. This makes such docs a good hedge against business cycle risk.

Second, I hardly ever buy any small-cap biotech stocks that are more than a few bucks a share. For me, the penny stock biotech stocks are more like call options without an expiration date in actual stocks because my downside risk is clearly defined and limited.

It will be interesting to see if my bullish call at this time turns out to be a bunch of bull. If I'm wrong here, we have been set up for one of the biggest bear traps ever. Given the massive uncertainties out there in the macro world, I wouldn't be surprised if this trap is sprung -- and I will be ready to try to evade it as much is possible with trailing stop losses. However, for now, I see the coast as clear.