Stocks finished at the highs of the day and set another record close. Holding recent gains suggest we are moving past the sideways summer trade and setting up to finish the year with a bullish up-leg.
Recent volatility cleansed the markets of weak owners and replaced them with a new crop of holders that demonstrated a willingness to sit through uncertainty and weakness. These holders are being rewarded for their confidence and patience as everyone with a diversified portfolio is sitting on profits. When holders are rewarded for holding and sellers regret selling, it further encourages traders to hold weakness and buy dips. While many will claim this complacency is dangerous and signals an imminent top, we must remember these things go further and longer than anyone expects. Markets don’t top due to confident holders, they rally because no one is selling and this keeps supply is tight. We don’t top until we run out of buyers, and given all the defensive and reactive selling we saw through the summer, there is plenty of demand itching to get back into this market.
Yahoo Finance put out a poll today that many bears will point to as a sign of complacency because the single largest response was from traders “not worried” about the rally. While this 48% is far above the 20% bullish responses we saw a couple of months ago, it is not concerning yet. If we consider the other responses, we see a quarter are selling defensively and another quarter are still sitting on the sidelines. That means 52% still don’t trust this market and remain potential buyers. 48% bullish and 52% bearish is many things, but it isn’t “irrational exuberance”.
Today’s strong close shows the rally is not ready to roll over just yet. A few weeks ago I thought we might see a sell-the-news following the debt ceiling compromise, but holding these levels for over a week demonstrates we are not running out of buyers. Anyone left out of this rally is looking for ways to get in. This pressure to chase will cause many to buy any and every dip. The more people we have buying dips, the shallower and less frequent they become.
This rally will end like every one before it. It is easy to predict what the market will do eventually, the hard part is getting the timing right. This rally leg is nearly a year old and the bull market is turning six soon, but there is no reason confident owners and money moving out of bonds cannot prop up this market for another twelve months. This is not a prediction, simply stating that markets often go further and longer than anyone expects. But it will end and it will happen when no one expects it. We can ride the confidence and complacency higher, but stay vigilant and look for cracks signaling deeper trouble.
Recent strength is putting pressure on underweight money managers who were waiting for the widely expected correction to take some sting from their under-performance. But instead the market is leaving them further behind and they have little choice but to chase into year-end. Ride this rally higher and use a trailing stop to protect recent gains from the unexpected. A stop under 1730 is not a bad place for a recent buyer to limit his exposure.
Plan your trade; trade your plan
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.