Market Action April 24, 2008 - End of the World Trade Unwinding

The short-covering rally continued today as the market rose on bad news and low volume. 

Up days have seen buying on heavier volume as of late, but Big Board volume has been in the 1.1 to 1.3 billion share range the past few weeks, well below the average of the past year.  On only one up day, March 20, has volume been heavy. 

We have resistance in the 1420-1430 range, which if we hit over the next few days as I expect, the relative strength index (RSI) will be near 70, indicating we are overbought. How the market  reacts from there will be  interesting.  If it consolidates and works off its over-bought condition, I would not be surprised if the market attempted to take out its highs (which I would expect to fail). 

In absolute terms, earnings have been poor.  In relative terms, earnings have been fantastic as most pieces of news confirm that, indeed, the economy is not on the verge of collapse.  This is causing relief rallies as shorts cover.  However, there is no conviction buying as money continues to stay on the sidelines. 

In the near term, I think the semis look very interesting.

I think a pull-back in the market is coming.  When it does, I may make a long trade in the chips with the intention of covering it a few months down the road.  We'll see.

The End-of-the-World trade is unwinding as investors rotate out of commodities and the euro and into financial stocks, the dollar and other risky assets.  Take a look at gold.

 

Gold, of which I am long, is sitting on a precarious spot.  It is down 13% from the top of last month. If it breaks down here, it could fall all the way to the $725-$800 level.  However, even at those levels, it would still be in a structural bull market. 

Remember that gold fell from $725 to $550, a decline of 25%, in 2006 before this most recent leg up. 

Such a decline could very well occur again as this crowded trade unwinds.  However, we are reaching a very oversold condition, which may provide a cushion. But an oversold market could get very oversold as we saw a few years back.  A 25% decline would put gold at $750, right in the middle of support. 

Also remember that even if this trade continues to unwind, gold and other commodities rose as stocks rose into 2007.  Even though they may move in opposite directions in the short-run, there is no reason why stocks and commodities would not go up concurrently over the intermediate term. 

My base case is for an anemic economy that sputters over the next few years, one where growth is capped as we work off the excesses in the financial markets and credit growth slows, but one that does not collapse either as fairly strong emerging markets and the lack of excesses outside of the consumer put a cushion under the economy.

This will bring about a trending market, I believe.  Stocks will trade in a wide range as we rally off news when we are oversold and the sentiment is too negative, then decline when expectations for a return to trend does not materialize and optimism is too great. This will be a stock pickers market, evidenced by those who can pick Apple and avoid Starbucks.

Though at least one of my positions has triggered a stop (sell to limit losses), the commodities bull market is still on.  Commodities may be in for a choppy few months, but like any structural bull market, declines should be seen as opportunities.