Stocks dipped modestly last week as they struggle to capture those last few points needed to push through all-time highs. Either this pause is building support for a sustained move higher, or it signals exhaustion just before the market rolls over.
A big part of why it is so difficult to predict the market is any setup ALWAYS gives contradictory signals. If the answer was obvious, everyone would make the easy trade and this one-way buying/selling brings the market back into perfect contradiction. Balance is the law of free markets and always makes sure both bull and bear views are equally represented.
To figure out where we are going, we need to search beyond widely followed technicals and fundamentals and uncover what the market is thinking and how it is positioned. This gives us the best insight into what comes next. Markets only move when people buy or sell, so obviously we need to figure out what will induce them to buy or sell.
In late-January/early-February we saw a similar consolidation and volatility around 1500, but the mood was completely different. Traders were still afraid and the popular expectation was an imminent pullback from over-bought conditions. That was six-weeks and 50-points ago. Now we see the same technical setup, but sentiment changed. Everyone feels good about the market’s strength and is looking forward to new all-time highs. This means most chasers are already in the market and few are left on the sidelines. Value investors sold to these momentum traders as prices climbed, but after the chaser, it is hard to figure out who is the next in line to buy.
Obviously markets can coast higher on momentum alone, but just because there is more upside doesn’t make it a good trade. This far into the rally there is limited profit potential and lots of downside risk, making a poor risk/reward. Day-traders can grab those last few dollars, but overnight traders need to be more cautious.
There is little concern left in the market. Cyprus dominated the headlines, but we are trading within 3-points of the pre-Cyprus close, demonstrating apathy from the market over these headlines. But it shouldn’t surprise anyone when a market that didn’t flinch on a negative GDP report last month, effortlessly ignores the struggles of a tiny Mediterranean island.
This upcoming week will be a key one for the markets. Holding level for a week is supportive, holding level for a few weeks becomes stalling and shows the market cannot get the job done. This is also the last week of the quarter and most quarter-end buying is behind us. For the time being, the chase is taking a break as money managers have a clean slate starting in April. Chasing could continue, but managers feel far less pressure to buy reactively when the finish line is three-months away.
The market needs to continue higher after this pause to prove it still has an ample supply of buyers. It doesn’t need to be a lot, but a healthy rally would finally reach 1565 and hold it this week. If a modest gain is constructive, then anything else is destructive. A dip under 1550 will likely continue because most of the dip-buyers came in last week and used up all their capital. A strong surge higher signals a potential climax and exhaustion of remaining buyers.
As of this writing, there is some kind of resolution regarding Cyprus that avoids a disorganized bankruptcy. This doesn’t do anything to save wealthy account holders, but it does protect the integrity of the banking system by upholding the guaranteed 100k safeguard. The market could rally on this, but Cyprus never posed much of a risk to the wider banking sector and the market never sold off on the news, so any relief rally will be short-lived and this story forgotten before lunchtime.
This is the rally that just won’t quit. When everything else is equal, stick with the rally because a rally can continue countless times, but it only reverses once. Every call for a market top the last three months has been premature and I have no doubt I am early here too, the biggest question is if that is 10 or 100-points early. Time will tell and we will continue watching the market for signs of strength and sustainability
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.