Chasing Away the Bears

 | Oct 28, 2011 | 1:49 PM EDT
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Everyone is aware that the market is extended and in need of consolidation in the short term. But the big question to ponder is what happens after things settle down? Are we looking at a near-term top as we head into resistance at the summer highs, or is this momentum going to continue and give us a strong finish to the year?

The bears' primary argument is fundamental. They tell us that the market overreacted to the news out of Europe and once it sinks in that the problems have not really been solved, we are likely to roll back over and struggle again. We popped because too many people were caught leaning the wrong way and nothing fundamental has really improved.

The bears will also point out that there has been a very loud chorus of complaints about how manipulated the move off the annual lows in early October has been. Many question the technical foundation of this whole move, even though we have had a classic breakout of a trading range to the upside.

Technically, we are obviously overbought and don't have a lot of underlying support since we went up in low-volume, V-ish fashion. If we don't hold the breakout levels we could gain downside traction quickly, but there are no signs of that yet. 

I can understand the bearish fundamental argument. It seems downright naïve to believe everything is suddenly fine in Europe, but this market has done a remarkable job of ignoring negative macroeconomic matters ever since the low in March 2009. If you have tried to time the market based on economic concerns, you have been crushed.  We have never had any shortage of negative fundamental arguments, but they haven't hurt the market much.

The one theme that has been persistent in this market over the last couple of years is that we have these sudden V-shaped moves higher that catch a large number of people by surprise and then keep on going, although common sense indicates it is time for greater caution. This action consistently creates a large supply of underinvested bulls and serial top callers, and their reactions tend to keep the market running despite the fundamental arguments and the poor technical conditions.

This recent market move has likely created similar dynamics again. There is substantial performance anxiety, which is going to make some bulls very aggressive into the end of the year as they try to find ways to produce relative outperformance.

I anticipate that we will have choppier action going forward and a continued bullish tone. I suspect that buying the dips is going to be the way to go. We need some pullbacks and consolidation, but I doubt the bears are going to take this market back down easily.

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