Sunday, June 03, 2007

Another Record High

Impressive economic data put a solid ending on a surprisingly strong week for stocks.

The NASDAQ printed another new, 6-year high on Friday, but unfortunately volume slipped 19%. New-high dojis on lower volume often suggest trend exhaustion. This may prove true, but dojis are also common as continuation patterns. The recent trend contains important twists which support this as a real possibility.

For starters, the IBD100 is on fire. Leading stocks outran the broader market for the 5th straight day on Friday. While the market saw fractional gains, the IBD100 shot up 1.2% as 72 of 100 stocks posted gains. Also, a stunning 34 of 100 stocks printed record highs, following 31 new highs on Thursday and 24 on Wednesday. Leading stocks are under serious accumulation, and this is definitely not the sign of a market near an important top.

Second, market internals extended their bullish streak to a 5th consecutive day as well. As a result, charts of the market internals look the best they have in over six weeks (see for yourself) . Volume or not, the market has demonstrated steady, internal improvement which is also inconsistent with topping patterns.

Third, all low-volume trade isn't created equal. Even though volume has been below-average this week, it hasn't been a random event. It's been part-holiday, part-seasonal, part-apprehension ahead of key economic reports. This makes the lack of selling pressure actually much more conspicuous, and probably more important as well. Trade may be low, but that's very different from saying that investors are ready to sell.

On one hand, the pair of gaps on the chart below raises the odds for a pullback. On the other hand, few things are more bullish than a pair of gaps. For now, the Composite looks like any dips will eventually be bought.

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Last weekend, I mentioned that the Composite weekly was perhaps the most promising chart of all. It shows the recent consolidation to the 10-week and strength of the breakout very clearly. It was a bullish chart then, and continues to be even more so now. There's a lot to like about the chart below.

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The bond market continues to sell off as US economic strength becomes more clear. As a result, investors have driven yields to levels not seen since Aug 2006.

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According to the mainstream press, a key reason for Friday's tepid stock action was the surge in bond yields. However, the chart below compares the 10-year Treasury yield with the SPX over the past 9 years. It shows three important things: 1) yields historically move in parallel with the stock market, 2) yields are actually no higher than in 1998 when the PE of the SPX was 30 (and climbing) vs. 17 today, and 3) bonds diverged from stocks in mid-2006 on recession fears, and now yields are playing catch-up.

Given the reason that yields are now climbing (i.e. no recession) , rates historically can move quite a bit higher before they have a significant effect on stock prices. Currently, long yields are still 6% lower than Fed funds, which equates to about 2770 on the NASDAQ.

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One of the most provocative features of the rally from July 2006-to-present is that it has been completely and utterly joyless. Even though the NASDAQ is up 29% (600 points!) since July, few investors have gotten any pleasure out of it. In fact, investor sentiment has remained startlingly low, even to the point of pessimism.

For example, over the past two weeks, the AAII Bull Ratio has fallen, even as the SPX printed a new all-time high and every major index printed record closes. Cynics say that investors are "so bullish", but the evidence contradicts this claim. Most investors are cautious at best, and certainly no one's having any fun.

Of course, this is textbook contrarian bullish. The reason for this is that statistically, people who say that they're bearish have reduced their long exposure. They're not "all in", which -- at record stock market highs -- is a very encouraging data point.

Note that the AAII Bull Ratio has fallen back to levels at the Feb 27 selloff, even though the SPX is a whopping 12% higher. Investors are grumpy and skeptical. They refuse to give this market any credit, and -- given the recent economic data -- few things could be more bullish for stocks.

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Who knows what Friday's doji will mean for the stock market by next weekend? What's clear is that the IT trend remains higher, and there are few signs that we're near an important top.

Three times in May, a slew of technical indicators said that the market was about to correct. I grew cautious and said so in these posts. However, the stocks in my portfolios eerily saw almost no distribution and gave few sell signals. In fact, even at the shakiest market moments -- as I was writing "adjust risk to taste" -- I personally was still 85% long. The stocks I owned were simply telling me not to sell.

Trusting the market continues to pay off handsomely, and I hope the market is treating you well too.

Until Monday, enjoy the rest of your weekend.



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