Wednesday, May 30, 2007

Shaking Off the Dragon

It's been very hectic this week, but I wanted to drop a quick post about the past two sessions.

The most bullish thing a market can do is to keep going higher. The second most bullish thing is to keep going higher while few people expect it. Stocks have pulled off a pair of low-probability upmoves this week that caught many by surprise. The odds were low because these moves required overcoming distribution days, divergence, bearish candles, poor sentiment, crappy internals, a stall in money flow and a surge in put buying.

It has also required ignoring weakness in the Chinese stock market. The Feb 27 Shanghai selloff rattled markets worldwide, and triggered a correction in US stocks. However, the next two Chinese selloffs in Apr and on Wednesday drew a yawn from US investors.

There appears to be some recognition that while the Chinese markets are correcting, the economy itself remains quite robust. This reaction is rational, encouraging and gives a fresh twist to that uniquely American expression: it's the economy, stupid.

As always, the most intriguing aspects of market action are often the imperfections. In this case, low volume is the elephant at the table. The NASDAQ tacked on 55 points in the past 3 sessions on volume 13% below average. Stocks are higher in part because of short covering.

However, market internals show that there's more to it than that. Breadth has improved, and both Up Volume and New Highs have accelerated. Also, the IBD100 has continued to outperform. It had one day of downside outperformance last week (the IBD100 version of a distribution day), but since then, it's outpaced the broader market higher.

The bears were unable to follow-through on last week's selloff, and the Composite is now parked just 0.3% below a 6-year high. Despite the light volume, various technical indicators have improved: MACD crossed over on Wednesday, Stochastics printed a higher low, and OBV has stayed positive.

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TOF made a couple of great observations in Tuesday's Old Fool Notes: when you try to write an obituary for this market, the words won't stick to the page; and the TOF Ratio still hasn't flashed a Sell.

My casual observation about the TOF Ratio is that the Sell signal is generated by the second 21-day/50-day crossover. The first 21-day touch (orange arrow) usually works as a warning, and stocks continue higher for a while. However, the second crossover (red arrow) is one to heed.

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Market action suggests that investors are focused more on this week's economic reports than they are on the overseas markets. Record highs on the SPX, Dow, WLSH, MID, RUT and NYSE point to a market expecting few surprises in these reports.

Should something unexpectedly negative appear, the bears will likely get another crack at pushing the market lower.



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