Getting a Bit More Cautious

 | Jan 13, 2012 | 7:49 AM EST
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Let our advance worrying become advance thinking and planning.
-- Winston Churchill

So far 2012 has been very positive for the bulls. The S&P 500 and Nasdaq have had only one slightly negative day as we have gone straight up. Volume hasn't been particularly strong and most of the gain has occurred on gap-up opens, but it is hard to argue with the price action.

I've been most impressed with the very strong dip-buying. We have not had a close anywhere near the lows of the day and every single pullback has been bought. The buyers are pouncing on any minor weakness, and that behavior generally becomes self-reinforcing the longer it continues.

When the market is acting in this manner, don't fight it. The easiest mistake to make in this market since the bottom in March 2009 is to believe that a low-volume, straight-up rally is about to suddenly come to an end. More often than not we have continued to rally far longer than many would think is reasonable and we almost never suddenly collapse.

One thing that tends to add to the inclination to look for a market top is that this sort of action results in fewer attractive technical setups in individual stocks. Many stocks are now overbought on light volume, and the breakouts have come and gone. Putting new cash to work is a challenge and that often leads to a bearish bias due to hope more than anything else.

Making a bearish case against this market isn't too difficult -- another thing that tends to keep it trending upward. The major thing that bothers me is the feeling of complacency, which in part is probably due to seasonality. Bearishness is quite low in the sentiment polls, but those aren't particularly good timing devices. In the shorter term the market has been ignoring quite a bit of bad news, such as continued weakness in the euro, poor action in retailers, yesterday's increased unemployment filings and the lack of any real resolution to the issues plaguing Europe.

The biggest negatives right now are the high expectations and sanguine mood as we enter earnings season. We have had more warnings and guide-downs this quarter than in many years (JDA Software (JDAS) last night was the latest), yet here we are with the indices hovering near their highs. It would be a good "sell the news" setup even if we were expecting some good earnings news.

Probably the biggest positive lately has been that the action in stocks is not as highly correlated and there is an increased focus on individual stock-picking. We have had some pockets of strong momentum and there have been some themes in things like biotechnology, solar energy, oil and China that have worked well. We haven't seen that sort of thing since the first half of 2011, and it does give the market a much better feel because we aren't being held hostage to the headlines.

The key now is that we be on guard for a change in market character as earnings roll out. JPMorgan (JPM), which is the first major report of the quarter, is out and is trading down on a miss in revenue and EPS. The stock had run up sharply along with the broad market, so it shouldn't be a big surprise that a less-than-perfect report is causing some selling. That is the danger in the overall market next week.

With the market closed on Monday I expected to see some positioning for reports that start to hit next week. Some of the major reports due include Goldman Sachs (GS), Google (GOOG), Microsoft (MSFT), IBM (IBM) and Bank of America (BAC). JPMorgan this morning should provide some clues as to how the market is likely to handle some of these reports.

One more thing to keep in mind is that the beginning-of-the-year seasonality starts to wane from here. According to, the Nasdaq 100 tends to top out on the eighth trading day of the new year. Today is Day 9, so we are quickly losing that tailwind.

I'm not a big growling grizzly, but the year has started well and I'm not inclined to give back gains. I'm concerned about the setup we have going into earnings and I'm going to proceed with utmost caution as the news starts to roll out.

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