Tricks and Treats

 | Oct 31, 2011 | 8:53 AM EDT
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"Hold on, man. We don't go anywhere with "scary," "spooky," "haunted," or "forbidden" in the title." --Shaggy from Scooby-Doo

After a huge week, the market looks scary this morning. Concerns that Italy will be the next domino to fall in Europe, the bankruptcy filing of MF Global (MF) and Japan's efforts to weaken the yen are the driving forces for negative action to start the day.

Of course, the bears' argument is that the huge Europe-is-saved rally last Thursday wasn't justified in the first place. Regardless of the news, it was obvious that market players were caught leaning the wrong way, which resulted in underinvested bulls and overly anticipatory bears scrambling to reposition. That, coupled with some end-of-month pressures, helped produce substantial upside momentum

The issue now is whether we enjoy the 'treat' of better technical conditions, or the 'trick' of negative fundamental news.

There is always a bearish fundamental case to be made, but it is probably more obvious than usual. The exuberance over the Greek bailout confounded many bears last week, especially since it was lacking in specifics and did little to deal with lingering problems in Italy and Spain. Many bears were looking for a sell-the-news reaction after the summit meeting Wednesday and were blindsided by the Greek bond haircut.

We held up well Friday as the news sunk in, and that caused even greater consternation for bears who were convinced that the rally couldn't possibly hold. They are feeling better this morning as the market opens poorly, but should we really expect this market to collapse now?

The bulls have improved technical conditions in their favor. A near-three-month-long trading range resolved to the upside, with substantial upward momentum for the entire month after hitting annual lows Oct. 4.

We have gone from oversold to overbought in V-shaped fashion on relatively light volume again, but we should be used to that by now. It has been the nature of the market moves since the bottom in March 2009 and the tendency has been for the moves to continue far longer than most market players think is reasonable. If you have tried to short this market every time it was overbought, you have suffered much pain.

While the market is technically extended and in need of consolidation, the momentum is strong and important technical levels have been regained. There is little technical reason to believe that it will collapse suddenly. In fact, some weakness is more of a positive than a negative.

It is very interesting battle, with the fundamentally negatives abundantly clear but the technical conditions suggesting that this market is in good shape for further gains after consolidation.

It's the bulls' game to lose. They can afford a stiff pullback, but they need to show some dip-buying conviction on weakness. End-of-year seasonality also tends to support the bulls at this point.

Will the negatives coming out of Europe send the bulls running to the sidelines, or will the fear of being left behind and performance anxiety keep the momentum going? If we can consolidate gains and shake out some profit takers now, I'll be looking for the bulls to continue to push. We'll have a good test of the dip-buying interest on the weak open this morning.

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