Be Ready to Shift Gears

 | Jan 09, 2012 | 7:34 AM EST
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The art of war teaches us to rely not on the likelihood of the enemy's not coming, but on our own readiness to receive him; not on the chance of his not attacking, but rather on the fact that we have made our position unassailable.
-- Sun Tzu

Despite some better-than-expected jobs news last week, it is very easy to make a bearish case against this market right now. Positive seasonality is coming to an end, problems in Europe are bubbling up (although we ignored them a bit last week), there are plenty of earnings warnings and indications that earnings season may produce tepid results, and the market still lacks leadership and momentum. In addition we have a high level of complacency, with the level of bearishness in sentiment polls at extremely low levels.

For the past couple years, this market has had a strong tendency to rally in the face of a laundry list of negatives like this. The single easiest mistake to make has been to be prematurely bearish. There has never been a shortage of arguments about why we are heading for an ugly fall but, more often than not, we continue to work higher as we climb the proverbial wall of worry.

Technically the market picture looks quite mixed right now, which adds to the difficulty of positioning. The S&P 500 has moved over the 200-day simple moving average at 1258 and is close to challenging the highs we hit in late October at 1292. While we did a nice job of holding above the gap on the first day of the new year, we haven't gained any traction subsequently. There have been signs of dip-buyers three days in a row, which is very encouraging, but they have been flipping into strength and have kept us under the highs of Jan. 3.

So how do we deal with this market? Select longs are working and we can stick with them, but that list is very narrow and the big picture is very mixed -- especially with earnings on the horizon. That uncertainty precludes loading up on position plays that need some sustained momentum. On the other hand, this is exactly the sort of environment that has tended to cause consternation for bears and underinvested bulls by continuing to walk higher on light volume.

My plan is to stay in a highly reactive mode and not try too hard to anticipate weakness until there actually are signs of it. I see more potential short setups that longs right now, but they aren't working well yet and need to be triggered to confirm that the bulls are going to relent.

The bulls have some ammunition with the jobs news and the market's ability to shrug off some problems in Europe last week. My concern is that the recent action may have had more to do with beginning-of-the-year positioning that had little to do with the merits of the overall market. Cash inflows had to be put to work, positions re-established and funds moved around regardless of the fundamentals of the market.

Be prepared for a market shift. The danger signs are building, and while we want to ride any momentum we can find as long as possible, we have to ready to shift very fast if conditions change. I'm trying not to be too negative too early, but I'm on guard.

We have some slight positive action in the early going although overseas action is mostly flat. There is no notable economic news on the agenda, and although Alcoa (AA) kicks off earnings season tonight, it is another week before the reports really start to roll in. Be ready to move. Things are likely to shift very soon.

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