An Excess of Hope

 | Oct 24, 2011 | 9:00 AM EDT
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"Hope is the expectation that something outside of ourselves, something or someone external, is going to come to our rescue and we will live happily ever after." --Dr. Robert Anthony

On Friday, hope for a solution to the European debt crisis drove the S&P 500 to its highest close since it broke down and fell into a trading range in early August. We have been bouncing around between 1100 and 1225 for a while and pessimism has remained high. But headlines out of Europe last week that some sort of deal between Germany and France is likely have kept the bears at bay.

Unfortunately, it has not been the easiest action to play. What has been most challenging is that so many market players have been caught out of position. Even the bulls are skeptical about how easily the European problems are going to be solved, but every time the market weakens, we are hit with new headlines about how a solution is near and off we go again. There have been few actual agreements or solutions, but that may be helping the bulls, who seem to have an excess of hope right now. As long as we are dealing with potential promises and no real news, there is no chance of disappointment.

If it were just the news flow that we were dealing with, the market action wouldn't be all that challenging or difficult to trade. What has really been frustrating for many traders lately is the nature of the rally action: it's just not normal.

The biggest obstacle for traders is that the action is highly correlated. Stocks are moving in lockstep to news headlines and there has been very little leadership or relative strength in individual names. In fact, a number of the leadership names such as Apple (AAPL), Baidu (BIDU) and Green Mountain Coffee (GMCR) have been performing very poorly. All that matters is that you are on the correct side of the news headlines and it doesn't really matter what stocks you own. Individual stock picking is not providing any edge.

I've been writing quite a bit lately about how earnings season might help shift the focus back to individual stocks, but there hasn't been any sign of that. Reports have been mixed, with AAPL and IBM (IBM) below expectations but Intel (INTC) and Google (GOOG) doing well. There are many more reports to come so that may still change.

Another obstacle for traders is that the market has not done a very good job creating favorable chart setups. This is partially due to the highly correlated nature of the action, which is driven by exchange-traded funds and computerized trading. But the most surprising thing is how we've gone for the lows of the year at the beginning of October to a new recent high without a pause.

I've written many times over the past couple of years about the tendency of the market to produce low-volume, V-shaped bounces and we are seeing it again. We never seem to pause or base to develop the sort of chart setups that traders tend to look for. Either you chase straight-up moves and take less-than-ideal entries or you are left behind. The fact that it occurs on low volume only makes it more difficult.

Virtually every trader I know is struggling with being underinvested. It isn't that they are bearish; they aren't able to find the opportunities that allow them to be aggressive at putting money to work.

We have a slight gap up to start the day as the focus stays on Europe. A deal is supposed to be done by Tuesday, and any indication that the deadline might not be met is going to be a problem for this market. It continues to be all about European headlines, but at this point some downside may actually help to return to a market where stock picking matters.

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