Still Climbing a Wall of Worry

 | Jan 18, 2012 | 8:38 AM EST
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"The passion to get ahead is sometimes born of the fear lest we be left behind." --Eric Hoffer

Since the bottom in March 2009, one of the most challenging aspects of this market has been its tendency to perform well when the mood is sanguine. We consistently see good uptrends and strong moves even though there is no real excitement or few positive feelings about the action.

So far in 2012, we have had another good example of this. We have been chugging along nicely in the first 10 days of trading, and sentiment polls reflect a very high level of bullishness, but we have very few signs of good old-fashioned momentum that tends to accomplish market moves like this in the past.

This is partly due to the most recent advance coming entirely on three gap ups on three successive Tuesdays. If we exclude those moves, the market has done very little, so it shouldn't be surprising that we don't have much strong momentum or wild buying. Market players aren't steadily accumulating shares and chasing strength. What has worked is guessing at what happens overnight. But buying the close and selling the open doesn't create momentum or excitement.

While the bulls have not produced sustained momentum, they have been quite aggressive buying dips. We have had excellent underlying support, which helps maintain a positive bias, even though the upside momentum is muted.

There are two emotions at work that give the market its strong support. First, is the fear of underperforming. These big gap-up opens that have produced all our gains have left many folks underinvested. It isn't that they are particularly bearish but that the market never allowed easy entry to be underinvested. Those folks are anxious to add long exposure, but they don't want to chase. Hence, they aggressively buy pullbacks and that keeps a strong bid under the market.

The other emotion at work is the wall of worry, which is a variation of the fear of underperforming. As has been the case for a long time, there is no shortage of macro concerns. Europe is still a mess, economic reports are mixed, earnings are problematic and we still have issues with unemployment and real estate. It is easy to make a bearish case and that creates pessimism, but when the market refuses to go down in the face of all those issues, it creates fear of being left behind. The longer the market holds up through the negativity, the more frustrated folks become and the more likely they are to put cash to work so they don't miss out.

The fear of being left behind is driving this market and it's the reason the action doesn't feel upbeat. Market players aren't buying because of optimism and positive feelings. They are buying because they are afraid that they may be wrong not to be more positive. The result is good underlying support but muted momentum and a lack of positive feelings.

Unfortunately, that makes for difficult trading as trend-following and a momentum approach don't work well. What works better is buying dips and flipping quickly for smaller gains. It's tougher to hold positions, and the risks are often higher, but focusing on relative strength has not been rewarded lately.

We are moving into the bulk of earnings season and that is going to be the main market mover in the near term. I don't expect the psychology above to change, but the risk of bouts of profit-taking are high if there's negative news flow.

The best approach is to focus on grinding out smaller gains and not to be too caught up in macro arguments. Stay quick and optimistic and try not to force a style on the market that isn't working. I prefer to buy momentum and good charts, but that isn't working so I have to adapt.

We have a slightly positive start. I look for strong underlying support to hold this market up reasonably well.

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