A Wall of Dominoes

 | Nov 07, 2011 | 8:18 AM EST
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Finally, you have broader considerations that might follow what you would call the "falling domino" principle. You have a row of dominoes set up, you knock over the first one, and what will happen to the last one is the certainty that it will go over very quickly. --Dwight D. Eisenhower

The good news overnight is that Greece was able to form a new government that will likely accept the bailout deal that was structured to save them. The bad news is that the market is now worried about Italy.

Futures jumped on news that Italian Prime Minister Berlusconi will resign, but fell back when he denied the talk. Interest rates on Italian debt are rising as worries grow, and that is our main hurdle as we start the week. 

Unfortunately, the issues in Europe are likely to be with us for quite a while as it is just a long line of dominos. As problems in one country are dealt with, it highlights the fact that other countries have similar problems. And if a messy default is allowed to occur in one place it is likely to reverberate down the line as the depth of the problems become more obvious.

There is plenty of discussion about how the issues in Europe will play out. But the big question for us is whether or not US markets can start to trade more independently of that news. We have been highly sensitive to the Greek drama for weeks, but the market has constantly jumped sharply on any positive news out of Europe, no matter how questionable it might be.

Market players are very anxious to move beyond Europe and there it quite a bit of fear that they will miss out if there are any positive developments. The reason we have had dozens of Europe-is-saved rallies is because there are some solid stocks out there with good valuations and market players are quick to buy them on any hint of good news.

They quickly become nervous again when there is more uncertainty in Europe, but they shift back to buy mode as soon as there is any excuse to do so.

Probably the biggest positive in the market right now is that Europe is helping to create a classic wall of worry for the market to scale. The negatives are very obvious and there is no clear solution, but the market has moved up sharply from the early October lows and that has created a big supply of underinvested bulls and very nervous bears. Too many folks have been left out and too many fund managers need to produce some relative performance.

What happens when there is wall of worry is that market players don't trust the market so they are holding excess cash. When we keep going up despite their concerns, folks start putting some of that idle cash to work because they fear they are wrong about the impact of the negatives and will be left out as stocks continue to rally. That buying pushes the market up a little more and makes more people worry about buying left behind, so they start inching in as well and soon there is a positive feedback loop in place.

It is the fact that we have such an obvious concern as the Europe sovereign debt issue that creates the dynamic for market players to be underinvested and unprepared for upside. If the market doesn't do what would appear to be logical and go down then that causes buying as no one wants to be left out.

In addition to the wall of worry we also have positive seasonality and the fact that a lot of companies have had pretty good earnings reports, once again. Technically we are a little extended but we did break out of the nearly three-month long trading range to the upside and we are holding support at the recent highs. The pullback last week was very technically healthy. We had become a bit frothy on the news of the Greece bailout deal, but we cooled off and allowed for profit taking and consolidation to occur.

As I've been writing lately, I'm optimistic about the market for some year-end strength.  Europe is going to continue to jerk us around, but the bulls are going to keep on looking for ways to move beyond that news. Charts are developing fairly well also so we just need to be ready to move as the action develops.

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