Stock Market Trend: Upward
This week I would like to pick at least a small fight with one of my favorite columnists, Michael Santoli of Barron's magazine. In his March 15, 2010 column, Santoli used his so-called Mystery Broker to predict a market pullback in the range of about 10%.
This use of an unnamed second party all seems kind of cheesy to me. The stock market isn't Watergate and Michael Santoli doesn't need Deep Throat to reveal secrets about its direction. To Mike, I say if you want to predict what would be a rather significant market correction at this point, then have the chutzpah to do it yourself -- don't rely on some unnamed ghost whose performance your readers cannot evaluate themselves because he chooses to go nameless.
As for the prediction of a 10% pullback (actually Mike indicated about 9%), I'm on the other side of that call for now. The only two technical analysis signs that any type of pullback or profit-taking might be in the offing include a fairly significant overbought condition for the market (cited by Santoli) and relatively low volume as the market has ground its way up over the past several weeks.
The problem with relying on an overbought condition signal, however, is you almost always see such signals when the market achieves new highs and is trying to establish a new leg up on a recovery. So all that really leaves us with from a technical perspective for the bearish case is low volume. That's a concern -- but hardly a trend breaker on its own.
Now, on the other side of the technical analysis ledger for this market, what Michael Santoli failed to mention are these facts: As Market Edge notes, both the momentum and strength indices for the broad market are positive while sentiment is neutral. Regarding broader market strength, of the 91 industry groups tracked by Market Edge, fully 83 of them are rated either strong or improving.
My bottom line on my Michael Santoli beef is that in presenting the case for a pullback, he only told you half of the technical story and used an unnamed cipher to do it. It's a weak case when you look at the bigger technical picture, which is perhaps why he may have wanted to hide behind his ghost -- if the pullback doesn’t happen, it’s no ding on his reputation.
Of course, loyal readers know that while I always use technical analysis as a tool to evaluate the market trend, I also only see technical analysis as a reflection of underlying fundamental conditions. These fundamental conditions currently make at least a decent case for being cautiously bullish.
The fundamental case begins with the observation that the stock market is a leading indicator of the economy. The economy of the US appears to be gathering strength right now; and this strength is being driven both by the inventory cycle fueling business investment in the GDP equation and a sustained and massive government stimulus (both monetary and fiscal policy). In addition, despite high unemployment and low consumer confidence, consumer spending remains above expectations. The only big cloud in America's GDP equation picture right now is the net export driver, which is likely to fall off because of the recent strengthening of the dollar.
For now, then, I see the broad technical strength of the stock market reflecting optimism about the improving US economy. That means, at least for now, that the upward trend remains intact and there is little sign of the kind of major pullback that Michael Santoli's Mystery Broker (and Santoli himself by implication) are predicting.
As for my trading strategy at this current juncture, I'm using a five-pronged approach. I am trend trading the Russell 2000 with a long position in IWM -- I prefer the Russell 2002 to the S&P 500 because there is more volatility and potential upside reward. Second, I'm using a sector rotation strategy, with long positions in transportation (IYT), materials (XLB), and oil (DBO). Third, I am using a geographical diversification strategy, with long positions in Mexico (EWW) on an improving US economy and Australia (EWA) as a hat trick play on commodities, China, and exchange rates.
My fourth strategy is my big macro trade of the year. I have a relatively large position in CYB, which is a bet that the Chinese yuan will appreciate over the next 12 to 24 months. The beauty of this trade is that there is virtually no downside risk because there is no imaginable scenario in which the yuan would actually depreciate.
Finally, my non-cyclical hedging strategy involves a perennial commitment of 20% of my portfolio to small-cap biotech stocks, typically under 5 to 10 bucks. I like biotech because stock prices are driven far more by the drug discovery process than by the business cycle -- ergo, the hedge. I like small-cap biotechs under 5 to 10 bucks because I can essentially trade them like options and clearly define my losses -- which is critical for very high risk biotechs. My current holdings include: CHTP, DUSA, HALO, LPTN, PBTH, SNT, SNMX, SCMP, and SVNT.
So that is my take for the week. Trade well and remember, to gamble is a sin but to speculate is divine.