Saturday, July 14, 2007

Topping Off the Tank

Investors couldn't resist adding a little extra to the pile on Friday.

Obviously, the market doesn't suffer from paraskevidekatriaphobia, as the indexes fearlessly notched a fresh set of new highs. It's worth noting that Friday's buying was met with little resistance, as the additional gains came on a 34% volume slide. The market tried to pause, but couldn't.

NASDAQ breadth was negative, but all of the other internals were strong. New Highs outpaced New Lows 569-167, a number almost identical to Thursday's total. This is a relatively high number of new lows for a market hitting historic highs. However, a closer look reveals that 40% of these lows were financial- and consumer-related. Right or wrong, the market continues to send the message that the subprime fiasco will remain contained.

Leading stocks echoed this view as they continued their climb. The IBD100 added another 0.7% while an impressive 36 stocks tagged new all-time highs. As the NASDAQ added a solid 4% over the past two weeks, the IBD100 has accelerated 7.7%! The market leadership is very healthy, and is telegraphing further highs for the stock market.

Nonetheless, investors continue to be wary. The Market-Needs-A-Pullback crowd has stepped it up a notch this weekend, despite the Dow's best day since 2003. How high does the market need to go before the skeptics turn bullish? According to fresh contrarian data, quite a bit higher.

Mark Hulbert is out with a new article that notes investment newsletter editors remain cautious, even after Thursday's breakout. The HSNSI stands this weekend at 40.6%. In contrast, before the Shanghai selloff in late February, the HSNSI stood at 62.4%, even though the Dow was 1,100 points lower.

It's not normal for the Dow to climb 1,100 points while investors grow more bearish. Markets need excessive optimism to put in a top, and there's simply too much pessimism for the market to quit moving higher. For example, if you believe, "This market is crap", it's unlikely that you're 100% long. Statistically, markets only stop once everyone is in. Regardless of what "targets" have been reached and what various "systems" are saying, the market itself is providing no evidence that we're near a top.

The NASDAQ is printing a remarkably strong daily chart this weekend. Money Flow crossing above 50 is particularly encouraging, as is ADX climbing after its first sub-10 visit in 18 months. There are few things more bullish than every index making new highs on the same day.

Image Hosted by

The NASDAQ weekly chart has proven itself to be a reliable compass of market direction. As the waffling daily chart gave conflicted signals for months, the weekly Composite filtered the noise and held a bullish bias. This week investors learned the weekly chart had it right all along.

The NASDAQ has posted gains in 12 of the 19 weeks since the March bottom. It also suggests that more gains are coming soon..

Image Hosted by

The evergreen appeal of the bearish position is its underlying sense of wisdom. It's hard not to sound prudent when spelling out market risk in the name of preserving capital. In contrast, the bullish position tends to sound reckless, greedy and even naive.

Each day, in addition to the mainstream press, I read through about 80 financial blogs (thank you Bloglines). The collective sense of these writers isn't happiness at the market's prosperity. There's a pronounced sense of concern -- and a touch of helplessness -- as if we're stuck in a car with a drunk behind the wheel.

It's interesting that liquidity, momentum, the Fed and greed/stupidity/ignorance are the favored reasons given for the market's rise. The disconnect is that this is never what really makes markets go up. Earnings do. Regardless of how much "liquidity" is out there, once companies put up lousy numbers en masse and guide lower, markets drop like rocks. The 34% rise in the NASDAQ since July 2006 hasn't been fueled by Fed repos and retail momo, but rather by three straight quarters of upside earnings surprises.

The six charts below show that there's about to be a fourth. Simultaneous record highs in Technology, Industrials, Materials, Energy, Transports and Cyclicals are evidence that there's more going on here than the PPT.

It's also a clue that the record NYSE short interest is in for the Summer From Hell.

Image Hosted by

I receive a large number of questions and comments best summarized as how much further can the market go? Most readers know that I don't set targets, ranges, limits, stops, etc. I have no edge in that game, and have never been able to consistently profit from these time-honored techniques (it's very unfashionable, but I simply buy really excellent companies and hold them until massive distribution triggers a sell).

Nonetheless, target fans should note that the NASDAQ confirmed above its 38% Fibonacci retracement on Thursday. After a 78% correction, this is a very big deal, and it's taken 5 years to get to this point. In a nutshell, TA suggests that the NASDAQ could run to about 3100+ before seeing a significant correction. That's roughly 15% above Friday's close. Few investors expect such an absurdity, which is of course this signal's biggest asset.

Image Hosted by

The titanium armor protecting the bears is that eventually they will be right. The bull market will end very badly with untold suffering, and Ursa Major will once more point to true north. There is little evidence to suggest that day is near, but this is as good a time as any to mention Deus ex machina.

The term describes the famous convention from Greco-Roman tragedy in which a new and totally unexpected plot twist appears at the end to abruptly alter the end of the story. In today's market context, Al-Qaeda could strike, we could bomb Iran, the credit debacle could reveal a Trojan Horse, there could be a natural disaster, etc.

It's tough to plan for Deus ex machina. As long as it's a no-show, the market itself is pointing to higher stock prices.

I hope everyone is having a great weekend. I'm off to pick up family from the airport, and we're looking forward to a fun several weeks.




aped said...

I read your blog every day, and its such an incredibly informative blog! Thank you for such a great, great blog!

dk said...

Thanks, aped. Hope you're well.