Where's the Remote?

 | Jan 05, 2012 | 8:29 AM EST  | Comments
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"We shall have no better conditions in the future if we are satisfied with all those which we have at present." --Thomas Edison

We are running a repeat of 2011 this morning as the market struggles on worries about European sovereign debt. The euro is at fresh multi-month lows, a couple of European banks have been halted and bond yields are rising sharply. It's like watching a repeat of a bad television show with the knowledge that you're sure to see it again very soon.

While the Europe issues are nothing new, it's still a concern. Positive seasonality is starting to fall off, the indices are slightly extended and the recent momentum has been tepid, which increases the risk of profit-taking.

Also troubling is an American Association of Individual Investors (AAII) sentiment poll has only 17% bears. According to SentimenTrader.com, that is the second-lowest showing in six years, the only lower reading coming the week before Christmas of 2010.

Given all the angst about Europe, it's hard to understand how bearishness could be so low but it is troubling if there really is that much complacency about the problems that exist. It raises the chances of a sharp correction substantially when there is the possibility that this many people could be caught leaning the wrong way. All we seem to hear about lately is how Europe is going to be a problem, but people seem to be numb to negativity after having to deal with it for years now.

While it is worrisome to see complacency, it is important to keep in mind that the sentiment polls are not accurate timing devices. Just look at what happened after the very low level of bears in December of last year. The market continued to run until Feb. 18, 2011 before a correction finally kicked in. If you shorted based on the low level of bearishness in December, you were killed. Sentiment is just one consideration among many to consider when looking at market direction.

I bring up sentiment because it is a headwind and may prevent us from "climbing the wall of worry," which has been the tendency for a couple of years. If we have so few bears, then there may not be much idle cash to keep driving us up, despite a laundry list of negatives.

I've been leaning more defensively the last day or two, as I want to make sure I protect profits from the Santa Claus rally. It has been nice to see a little bit of hot money, momentum action in small-cap energy stocks, but this market still lacks leadership or themes.

One of the things that really plagued us in the second half of 2011 was that the Investor's Business Daily momentum style did not work well. We just never had groups or sectors, and there were only a few big names trading at their highs.

Stocks were too highly correlated and moved in tandem with European news. Stock-picking took a backseat to short-term market timing, and I'm not convinced that is about to change.

I'm going to lean a bit more defensive here, especially since I don't see many places to load up for position trades. We need to muddle through the European issues again and then deal with an earnings season that has already seen the most warnings in years. The fact that there are so few bears doesn't give us much short-squeeze fuel, either. I'll be looking to pick off some longs again, like we were able to do in the energy sector yesterday, but I'm afraid upside momentum offerings are going to be slim.  

It is a good time to stay open-minded and selective and let the trades come to you.

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