Stocks are Now Overbought and Bumping into Resistance

Although the stock market is overbought and due for a pullback, my current working thesis involves the idea that the market made a costume change on December 20th. Suddenly and without warning, the uber-violent environment in which intraday moves of 3% were common stopped. And then starting on December 21st, something that investors hadn’t seen in nine months returned to the corner of Broad and Wall – some sanity. Thus, it appears that the Dr. Jekyll and Mr. Hyde market that ran amuck for the better part of 2011 has morphed into a good old fashioned, non-news-induced, non-HFT, fund-buying-driven uptrend.

There is no denying that the market’s tone has been different over the past five weeks. However, the bears have plenty of arguments to explain the recent lack of volatility including the obvious lack of interest during the holidays, the fact that the fast-money oriented hedge funds tend to close their books during the last couple weeks of the year, and that institutional funds tend to get new money to put to work in the early part of the year. As such, our furry friends are adamant that the change in character will be short-lived and that the bad old days are just around the corner.

On the other side of the field, the bull camp is having nothing to do with their opponent’s offerings. The primary arguments coming out of the glass-is-half-full gang are (1) “It’s not the news, but how the market reacts to the news” that matters and (2) unless the crisis in Europe takes a wrong turn, we’ve likely seen the worst.

Although the bear camp is quick to counter that the market is overreacting to the recent string of “good news,” it is important to note that all the news isn’t necessarily good these days. There is still no deal in Greece, which means that a hard default is still on the table. No one wants to voluntarily commit money to the European bailout funds. Portugal is looking like the next Greece. And the banks in Europe still are a big fat problem.

However, the key point I’d like to emphasize this morning is the market is not reacting negatively to every headline out of Europe these days. And as such, the bulls contend that the change in market behavior means the crisis may be coming to a close – at least in terms of being the primary driver to the stock market.

So, should investors suddenly make a u-turn in their risk management strategy? Is it time to jump back to the pool with both feet? Is it going to be clear sailing ahead for the stock market? In a word, no. Recall that our cycle work (which works really well when it works and is utterly useless at other times) is calling for a bear market in the middle of the year. However, the key is to recognize that markets and the emphasis of traders tends to change over time.

While I am confident that stocks would get slammed should something new develop across the pond, it appears that the U.S. is being viewed as the best house in the bad economic neighborhood this year. And from where I sit, this explains why the dip-buyers have been relentless so far in 2012. The question, of course is just how committed the buyers will be when things turn ugly. And given that stocks are now overbought and bumping into resistance, some ugliness could be just around the corner. But for now, I’m sticking with my theory that we’ve seen a costume change and that going forward, things will be different than they were over the past six months.

Turning to this morning… Concerns over the lack of a deal in Greece and new worries about Portugal are overshadowing a better than expected T-Bill auction in Spain and decent preliminary PMI date in Europe. And with a flood of earnings as well as the Fed on tap, the pullback being seen in the pre-market is to be expected.

On the Economic front… There are no economic releases scheduled before the bell.

David Moenning
Editor:  The Daily Decision