How Markets Are Like History

 | Jan 03, 2012 | 4:00 PM EST
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Around this time every year, something seems to keep many investors sidelined. Then, out of nowhere, a rash of gap-up openings across the board gives that money a chance to chase the market higher.

We saw it last year in the first session of 2011 -- big gap-up openings followed by pullbacks. But the gaps persisted, at least in the S&P 500 Futures, where gaps tend to matter most. In last year's first trading session, the market gapped up with futures popping sharply from the 1253 level, reaching a high of 1272 in early trading. But like today's rally, the high was made early in the day and futures pulled back from there. In the cash, there was no gap. But the gap in the futures at 1253 acted like a magnet for the market when it finally sold off into the mid-March lows for the year. That selloff to fill that gap marked the lows prior to the big surge into the May multi-year highs. It was certainly a tradable low, even though it would be smashed later in 2011.

So who cares? Well, I do, and so should you, as history has a way of repeating. The pattern in the new year already looks eerily familiar: big gap-up openings across the board and pullbacks well into the opening gap in the futures.

This time around, something worth noting is the bullish island reversal in the S&P Futures and E-Mini but not anywhere else. Here the bullish island runs from 1273 to 1264.50, or at least it did earlier today. It's already narrowed a bit as the futures have pulled back to the 1270 level (not shown on the chart below). Taking out that island at 1264.50 in the futures will be the first objective of the market on the downside. Eventually, I'd look for the entire gap at 1254.50 to be filled, but if this year repeats last year's pattern, it might not happen for two or three months.

S&P Futures (March E-Mini): The only way to see the bullish island reversal.
Source: R.J. O'Brien Futures

Speaking of patterns repeating. Did you notice where the S&P 500 closed Friday? Just 0.04 below where it closed the year before. That's no accident. It's the market's way of telling us that we haven't seen the last of that level around 1257 in the cash. This morning's gap-up open from 1257.60 is another way of telling us the same thing.

S&P 500 (SPX): Gapping up from unchanged levels for the year.
Source: optionsXpress

Of course, one big reason for today's sharp pop in the market and in just about everything else was the shakeout in the U.S. dollar and a pop in the euro. As I mentioned in Friday's column, one reason I was getting excited about the bullish side of gold (and, no, I'm still not bullish of gold but I am bullish ON gold -- or at least I was last week) was the expectation for a rebound in the euro from 11-month lows and a related shakeout in the greenback. That's what we're seeing today.

Oh, and there's the Santa Claus Rally, which has one more day to go to complete the pattern. That's one party I don't want to be the last one to leave, so I'm cutting back bullish bets a day early. I'm already taking partial profits in my SPX positions at the morning pricing at Rydex of 1282.51, and I'm planning to cut back further in my gold and precious metals positions at today's close.

For futures traders, after I recommended buying last week at the $1540 level, I am now recommending holding long but tightening the stop to $1584.


February Gold: Popping as the greenback sells off.
Source: R.J. O'Brien Futures


Good news for my Mutual Fund Switchers is that, again, the Precious Metals Fund at Rydex, which closely follows the Philly Gold and Silver index (XAU), is likely going to have a big pop today. That fund is already up 3% from our purchase last Wednesday with gold up only modestly. Today, with the XAU up better than 3%, the precious metals' shares should really pop. Now that minimum upside objectives have been satisfied with the gaps from Dec. 27 and Dec. 14 filled, I'm ready to reduce exposure further.


XAU (Gold and Silver Index): Returning to its Dec. 14 gap.
Source: optionsXpress


The McClellan Oscillator, which closed at the +74 level on Friday, is already approaching overbought levels. It should be fully overbought at today's close if the market closes anywhere in this area. That just makes me more cautious for the near term.

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