WR & LA: Does this rally have legs?

Weekly Review & Look Ahead

MARKET BEHAVIOR

The S&P500 was up decisively last week with a 4.5% gain.  Weekly volume was less than average, but the holiday shortened week played a big role in that.   The market is up an impressive 120-points since the post-election bottom in mid-November.  For as bad as the headlines and sentiment have been, we are a fraction from new 52-week highs.  Just another example of the contrarian trade being the right trade.

MARKET SENTIMENT

Obviously the big catalyst was the last-second Fiscal Cliff compromise, but the size of the rally had less to do with the news and primarily driven by the imbalance in trader sentiment and positioning.  Most traders were expecting us to fall off the cliff, sold ahead of time to avoid the near-certain collapse, and the market exploded higher when things turned out less bad than feared.  This was a beautiful asymmetrical trade.  Most of the selling occurring ahead of time, limiting the downside risk, and the oversold condition created a coiled spring to the upside.  A savvy trader prints money with setups like that.

The actual Fiscal Cliff compromise is nothing to get excited about and we will be back on the brink in a matter of weeks as the Federal Govt hits the Debt Ceiling.  Fundamentals are just as bad today as they were last week, but we find ourselves 5% higher because shorts were forced to climb over each other to cover their positions.  Normally this lays the foundation for a pullback, but after the market’s most recent rally, skeptics are a dime a dozen and it is these remaining skeptics that made the market drift higher in the later half of the week.

TRADING OPPORTUNITIES

Expected Outcome:
Overbought markets correct fairly quickly.  We saw two support days on Thursday and Friday, suggesting we are not overbought and have more upside before the inevitable correction.

Monday’s price action will go a long way to let us know what direction this market wants to go.  A breakdown signals a retest of the 50dma.  Anything short of a breakdown shows this market is not ready to selloff and another short-squeeze is on the menu.

Shorting the market here is a bad idea and instead wait for the breakdown before jumping in front of this rally.  You’ll be a little late, but you will reduce your risk exposure dramatically.  Further, a short here is a counter-trend trade, so don’t get greedy and take profits early and often.

For longs, we are closer to the end of this rally than the start and it is too late to chase this winner.  For those on the sidelines, the best trade is to wait for the next opportunity.  Any swing traders start looking for opportunities to lock in profits wait for the next trade.

Alternate Outcome:
The market doesn’t always do what it is supposed to and if we don’t see one of our expected scenarios play out, step aside and wait for the next opportunity.

INDIVIDUAL STOCKS

AAPL finished up for the week, but well off the weekly highs as the stock sold off on market share concerns.  The stock is still comfortably above the $500 level, but technical will become meaningless after earnings are announced this month.

A couple of months ago everyone was bullish on AAPL, but the recent pullback brought out the cynics and they’ve become more vocal with every leg lower.  As popular as AAPL is, it has created a lot of passion on both sides and the stock will most likely move strongly one way or the other after earnings are announced.  One side will be decisively victorious and the other will run home with their tail between their legs.

With the lowered expectations, the higher probability trade is to the upside.  Of course there are no guarantees and that is where prudent risk management is essential.  No matter how good a setup looks, always trade so you can live to fight another day.

ET CETERA

I changed web hosts over the weekend and that caused some downtime.  I’m doing my best to ensure a smooth transition, but if you notice something not working, please let me know about it through the contact form above.  Hopefully it will be a seamless transition for everyone.

Stay safe