Friday, July 8, 2011

No "Buts" Here...That Was Some Rally

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

The second quarter of 2011 was characterized by weakening economic data and the reemergence of the sovereign debt problems in Europe, especially Greece.

For much of June in my weekly Street$marts newsletter and last week on this blog, I wrote about how bad the headlines have been with Greece, Europe, awful employment numbers, Case-Shiller home price index at fresh 9 year lows and the Fed's Quantitative Easing II was coming to an end on June 30. It certainly felt like the stock market should be down 10-15%, if not more. Yet when you look at the chart below, the market completed its fourth 4-8% normal and healthy pullback since the major low on July 1, 2010.

You can also see from the chart that the S&P 500 touched the dark blue line, which represents the average price of the last 200 days. It is not uncommon for the market to visit this long-term trend gauge during periods of weakness.  Interestingly, the 1250 area in pink on the chart was not breached during the decline. That's one thing that did surprise me. Typically, when the masses become so focused on a certain level, the market has a funny way of running through that number for a day or two, causing investors to take action and then reversing in the opposite direction leaving many people holding the bag. This is called a trap.
As I wrote about last month, the impending (and current) rally would be fueled by sentiment shifting from exuberant to despondent after only an 8% decline.  Newsletter writers, often wrong at turning points, had become almost uniform in calling for a market correction after we had already seen a 6% pullback. Option players, especially smaller ones (usually mom and pop) were positioning for a correction, seeking the protection of put options after stocks were down 6%.  That group is usually wrong when there is a strong consensus. 
Technical measures, like the advance/decline line, up/down volume and their derivatives had become as oversold as at any point since the bull market began.  Intra-day gauges we created and use in-house were showing some mass selling right near the bottom.
On the flip side, buying by corporate insiders began to pick up after only a 5% decline. This group may be wrong in the short-term, but they usually get it right the longer out you look. At the April stock market high, we saw junk bonds, the advance/decline line, Dow Transports, Russell 2000 and S&P 400 all score all-time highs with the Dow, S&P 500 and NASDAQ at multi year highs.  Although that doesn't insulate the markets from a decline or correction, historically, bear markets do not begin with so many positives at a peak.

So as I write this, we have now seen 8 straight days and 11 out of the last 13 where the bulls won the battle. That is unusually powerful momentum. During bull markets after a decline, that is confirmation of new leg higher beginning.  During bear markets, a move like we have seen is best sold in to. Contrary to the emails I have received and arguments from my peers, we are still in a bull market folks. And with the Dow Transports scoring an all-time high today, we have further confirmation.
From here, we need to keep an eye on which sectors are leading and make sure all of the major indices also make new highs, including high yield (junk) bonds. Friday at 8:30 a.m. is the release of the monthly employment report. With stocks coming so far, so fast, I would expect a strong opening to be viewed as a good very short-term selling opportunity for the market to gather itself, a pause to refresh if you will.
FYI, I will be on CNBC’s Worldwide Exchange on July 13 at 5:35am.
Feel free to email me with any questions or comments at
Until next time…
Paul Schatz
Heritage Capital LLC
Follow us on Facebook at and on Twitter @Paul_Schatz

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