The market is overbought. The market is on the verge of a generational run higher. The pundits go back and forth on the aftermarket shows as to where stocks are right now.
The problem with marketsthat upside and downside are typically mutually exclusive. Hard to find a market that is overbought that is also a simultaneous generational buy. Sure there are niches of exceptions to the general rule, but we are talking about putting the probabilities in our favor, not putting it all on red for a spin of the wheel.
Perhaps, however, there is one combination that works. A market that tests near term in deference to the high bullishness, works out the froth of the post-election rally, then starts higher anew for another strong run. That certainly provides the tidiest of scenarios, though getting there is always difficult if you are not looking at the bigger picture.
The stock indices certainly were not giving a lot of clues Monday. They continued their lateral consolidations from last week, the large caps still waiting for the 10 day EMA to catch up, the small and midcaps holding their 10 day EMA's. That is not bad action at all, and during this rally that action has led to new upside. But for the size of the rally to this point and some other headwinds from the FOMC and even the republican Congress as to the now official President Elect Trump, this action suggests more upside.
SP500 4.46, 0.20%
NASDAQ 20.28, 0.37%
DJ30 39.65, 0.20%
SP400 0.61%
RUTX 0.55%
SOX 0.98%
VOLUME: NYSE -64% from that Friday expiration trade. NASDAQ -37%.
A/D: 1.6:1 NYSE, 1.3:1 NASDAQ
If the market does not use the current lateral consolidation as the prelude to a new leg higher in the rally but instead uses it as the introduction to some deeper testing as a result of the bullish level hitting near 60, that would mean more than just a weeklong fade as shown thus far during this rally. Something with more teeth and more duration, something you don't necessarily want to be in on the upside while it occurs.
Then, after that deeper pullback, the market likely shows a new move higher, one that can be bought hard. At that juncture yes, there could be some generational buys such as on BAC that broke out from an 8 year consolidation formed during the Fed's close to a decade of 0% interest rate policy.
Thing is, right now the market does not look as if it is about to embark on more serious selling. Sure it is in the process of assessing where it came from and how far it has travelled, but the outcome of that assessment does not have to be 'okay, we should sell off now.' There is no doubt bullishness is at a level that suggests the rally has to test deeper, but as discussed over the weekend, the timing mechanism in sentiment is not a direct correlation. It happens, it just may take some time.
Yes there is struggling leadership that led the move, e.g. metals, industrial machinery, but most are in orderly pullbacks (e.g. transports, financial, semiconductors). Some new areas are trying to come around, e.g. telecom, drugs.
Thus far the new leader wannabes are not enough to push the market back upside. Those leaders testing need to kick back upside and the wannabes continue to build into leaders for that to happen. For now, the market is holding the gains, digesting the last move, assessing what the Fed said and how that plays with the Trump reflation trade.
During this period we cautiously buy new positions while letting existing positions work. If the market breaks higher, of course we let them run, pick up new positions as they move. If this lateral consolidation does not yield another break higher as it did last time then the market is likely in for deeper selling commensurate with the higher bullishness reading. At that point we protect positions, i.e. closing them and waiting for the next round of leaders to set up their patterns to launch the new move.
Monday we saw some of those wannabes from new areas make some moves. MNKD in biotech, CIEN and HLIT in telecom, though HLIT came back on us some on the session. The internet plays are working well as that group emerges, e.g. LIVE, LLNW. There are other groups with desires on leadership, and if this lateral consolidation is going to break higher once more they will need to live up to those aspirations.
Have a great evening!
Jon Johnson, Chief Market Strategist
InvestmentHouse.com
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