Weekend Update: The Fed, The Scared Shorts, and All-Time Highs

This was an interesting week for the markets. There seems to be much push and pull at the current trading levels and the near-mid term direction is cloudy (but when is it not?). The week opened flat with low volume trading being done likely because of the upcoming Memorial Day holiday and the pending Fed Minutes that were to be released Wednesday morning. After hearing the testimony on the economy by Ben Bernanke, stocks soared Wednesday morning to reach yet again another all-time high for the SP500. However that rally was quickly and heavily sold, reversing the entire mornings gains and taking the SP500 below the weekly opening price (which we haven't seen since May began). That trading action created an "outside day"  , eclipsing both the prior days highs and lows, and is typically a short term warning signal.

Sure enough the market was sold hard to open Thursday's session, but that weakness was quickly slowed and steadily bought throughout the day. The same scenario played out Friday as well, morning weakness and slow bounce off the lows. The volume of shares traded this week were higher on the sell side and lower on the buy side. This signals the first indication of some distribution coming into the market. However it was interesting to still see how much interest there is to buy any and every dip, that should not be ignored at this point either.

Its hard on the Shorts right now; those betting against this market are being extra nimble and careful not to be exposed any longer than they have to. What we are seeing is the Shorts are willing to take a stab at a pullback but they are then very quick to cover their positions and take the small gains. They fear the Fed, the under invested and lagging money managers, also the slowly improving retail investor and his/her cash finding its way into the market on any opportunity. And you know, they should be afraid of all those things, those are steady tailwinds behind this market. As long as the Shorts are unable to sustain any real selling there should be little fear on the long side of this market. Basically what they are spouting about is the likelihood of the Fed reducing its stimulus soon and the other is that markets have risen too far, too fast. These reasons to me are really just "feelings" the shorts are having to justify their claims, and not really backed up with significant evidence to trade off of.

A new blog I am following and consider a must read is Alpha Capture written by Jon Boorman. He nails
the idea that the bears and "top-callers" in the financial media have a decent setup to their trade (story) but there is simply no price trigger to trade that setup. Here is a link to this post, "Calling Out the Top Callers". Do read it, it is a fantastic post and blog!


Some things to remember:

--Hard counter-trend moves are typical in strongly trending markets, there is the slow grind higher and the sharp snap back reactions. These typically resume in the direction of the prevailing trend.
--The big money is always looking for strong positive news events as the opportunity to sell. If you were in there buying the Fed day rally then you played right into the "smart money's" hands. Beware the "sell the news" trade.
--We are entering into the summer doldrums with low volume trading and historically flat returns vs the other half of the year. Usually November-April are the strongest market months and May-October are the weakest.
--While we have seen more weakness this week than we have seen in a while, the economy and jobs markets are slowly continuing to improve.
--The Fed is not likely to reduce stimulus heading into the slowest time of year for the markets and the economy. There has been too much talk and speculation that the Fed will be "tapering" the QE program in the near future. Listen, follow what IS happening, not what someone says might happen. Right now the Fed is pumping, markets have rallied due to it and its not going to vanish any time soon.

On that note I want to take a look at the longer term views of the Market and just show where we have come and are likely to continue.

This is the monthly chart of the SP500 going back to the mid 80's:

After the monstrous climb in equity prices from 1980-1999, the market has basically traded in a sideways range for the last 10-15 years, consolidating those gains. It is just now breaking out from those prior highs; remember how these range consolidation patterns work? They typically work as continuation patterns, resolving in the direction of the current trend. The measured target from the range breakout projects about 900 points of upside are to follow a sustained break and hold of this prior high level. The outlook long-term from this pattern is very bullish for stocks.

On the other hand, a "potential" sticking point for the near term rally is shown on this weekly chart:

I shared this chart in my post that went out last Wednesday; this is the weekly bar chart for the SP500 showing the rally off of the 2009 lows. This just presents us with a possible resistance point in the near to intermediate term (which would work perfect for the summer slow down huh?). We will be watching this level closely over the next couple weeks to see how traders respond to the new upper boundary. Personally I would love to see some sideways trading action for several weeks if not months. I know we all like higher prices, but just dumping new money in after the 100 point rally we have seen over the past month is tough to do. While its the market's job to make it tough sledding for us investors, we simply need some new bases and support to trade off of. Taking a new position here means a reasonable stop won't come into play for at least 50-60 S&P points and that is a stretched risk/reward scenario.

Right now I recommend only holding what you feel comfortable holding through a possible correction down to the 1575-1600 level. If you are too overexposed to hold your current positions through a move like that then you likely need to reduce your overall exposure. For me holding roughly 60/40 stocks to cash seems about right. My current holdings are sized properly that I can easily withstand a 10% correction and not freak out and panic them away. If that scenario does in fact play out, then we would be reassessing the validity of our positions at those new levels.

From what I can see across the markets, it seems that the consumer is strong, housing is improving, jobs are growing gradually and the Fed is stimulating. Its still a very strong environment for stocks even after the seemingly endless rally we have had. That being said, I think there are certain areas that you should be positioning towards in the market and not just blindly buying because everything is going higher. Those areas include:
Consumer Discretionary
Health Care
Financials
Staples
Transports (I like the rails)

These are all plays on the improving consumer, aging demographics, job growth, loan growth and housing.
Those are the strongest trends in our improving economy and that is how you want to position yourself going forward. Always align with the strongest groups when investing and leave the laggards for the "heroes" to sort out. Don't be a hero, invest smart, safe and consistently aligned with the trend.