Boiling a Lobster

MARKET BEHAVIOR
The slow motion slide continues for a third day.  The givebacks have been minor, less than 1/3 of a percent each day, on light and declining volume.  The market remains above previous resistance at 1,775 and is well above the 50 and 200dma.

MARKET SENTIMENT
So far everything looks great.  We are near all-time highs and the market is not fretting over a looming catastrophe.  This has to be the first time this year the market is not obsessing about something.  Even the last three-days are nothing to worry about since down-days are part of every advance.  This dip is so modest and orderly, few are worried about it.

But here is the thing, the market rallied through 2013 in spite of a nearly constant barrage of fear and pessimism.  You could even say the rally fed on it.  While it is great everyone feels so upbeat, should we be concerned about this shift in sentiment and outlook?

Declining volume shows many are not interested in selling this weakness.  Low-volume was very bullish this year.  The lack of selling keeps supply tight and makes it easier for prices to rally.  But no matter how tight supply is, we still need enough demand to keep up.  More than a bearish headline, the biggest risk for this rally is running out of buyers.

While I am not a bear by any stretch of the imagination, it is often noted that bull markets top on good news.  This is the headline that finally signals all clear and invites the last of the holdouts to jump in.  But no matter how great things look, markets decline without new buyers.  Between the elimination of fear and bullish feelings following Yellen’s confirmation hearings, could that be the good news that got everyone in the market?

There is a fundamental difference between headline driven selloffs and running out of buyers.  Unexpected headlines send everyone rushing for the exits at the same time, markets drop precipitously, but they find a bottom quickly.  The emotion and herd driven selling capitulates relatively quickly and allows the brave contrarian to buy heavily discounted shares from fearful sellers.

Demand driven selloffs are completely different.  Everyone feels good and they largely ignore weakness, assuming it is yet another buyable dip and they would be foolish to sell the weakness.  The market slips slowly, failing to raise any alarms or make holders nervous.  This is analogous to boiling an oblivious lobster by raising the water temperature one degree at a time.  In individual stocks we’ve seen this behavior in AAPL and TSLA.  Are we on the verge of seeing the same thing in the broad market?

While I am reluctant to call a top, the recent change in sentiment and outlook is enough to concern me.  The best trades are the hardest to make.  Owning this market feels way too easy and that makes me suspicious.  We profit by owning risk, not comfort.  Things feel too comfortable for my taste.

TRADING OPPORTUNITIES
Expected Outcome:
It’s been a great ride over the last 12-months, but we all know this cannot go on forever.  No doubt I am likely premature, but it feels like sentiment is shifting and that invariably triggers a new a behavior from the market.  Maybe we trade sideways for a while.  Maybe we dip far enough to bring fear back into the market.  We won’t know when and how far this will go until we are in the middle of it.  Right now 1775 is the key level to watch.  After that it is 1740 and then the 50dma.

Alternate Outcome:
These things always go further and longer than anyone expects.  We are twelve-months into this rally leg and there is no reason it needs to end here.  As long as people keep buying the dip, this market will continue marching higher.  The current stretch above the 200dma doesn’t even come close to the record.  Doubting this market is going against the trend and countless traders have died for the cause of “too-far, too-fast”.

Trading Plan:
It all comes down to risk versus reward.  What is the upside from holding here as compared to the downside?  How much higher can the market go in the remaining months of the year?  How far can it fall?  While it can easily continue higher, a modest reward might not be worth taking an outsized risk.  We are in this to make money and the only way we can do that is by selling our winners.

INDIVIDUAL STOCKS
TSLA slipped to recent lows and gave back most of yesterday’s bounce.  While there is lots of room for this stock to bounce back, in situations like this it is better to be a little late than a lot early.  Wait for this stock to find a bottom before jumping in.  That means holding current levels for at least several more days and then buying the high volume bounce off a key level.

AAPL is holding support above $510, but other than that small ray of hope, the stock is lifeless.  The recent product launches and big name investors failed to reignite the growth stock.  While the dividend is nice, that might be the best part of owning this stock over the next decade.

On the other side of the fence, MSFT is near 10-year highs as investors cheer an impending change in leadership.  It also doesn’t hurt that the Windows phone doubled market share.  While the numbers are much smaller than the iPhone and Android, they are making the largest share gains, largely at the expense of BBRY.  It will be interesting to see what direction the next management team takes these promising phones and tablets as consumers start demanding full-powered mobile devices.

Plan your trade; trade your plan

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