"A pessimist is one who feels bad when he feels good for fear he'll feel worse when he feels better." --Unknown
Since the market low in March 2009, the easiest mistake for investors to make is to be too bearish due to concerns about the macroeconomic situation. We have dealt with a struggling economy and the growing European sovereign debt issue for almost three years, but despite the obvious negatives, the market has performed remarkable well.
The belief that another shoe is about to drop and the market will fall apart again has kept many market players underinvested or downright bearish. These folks, who have good reason not to be very trusting, are chronically underinvested and end up driving the market even higher as it embarks on one of its many V-shaped rallies.
The big danger for the bulls in this sort of environment is that we never know when the market will decide that the obvious negatives will matter. Yesterday, the market shrugged off the drama in Italy and the fact that Berlusconi was trying to buy time to save his own skin, but this morning the fact that the yield on Italian bonds is ballooning above 7% is causing worries of a debt contagion. With Italy under pressure, how much longer before it spreads to Spain, France, the U.K. and even the U.S.?
Ironically, it is this consistent lack of trust in the macroeconomic environment that is the biggest market positive. Market players have consistently struggled with being underinvested. The big V-shaped move we saw in October has once again created a large supply of frustrated bulls who missed the move and are now anxious to buy pullbacks to catch up. They have not had many chances to buy weakness and, as we saw over the last six days, they can bounce this market fast once they jump back in.
Of course buying dips and pullbacks is always much easier in theory than in practice. When we have an open like we are setting up for this morning, the natural inclination it to seek safety rather than to rush in and buy the weakness. Once a bounce starts, the worries about being left behind again can kick in fast, but dip buyers usually want to see someone else step up before they rush in.
Another positive the market has going for it, in addition to the lack of trust in the big picture, is that there are plenty of stocks with solid fundamentals that are unaffected by the global economic malaise. There is no shortage of folks who would like to buy Apple (AAPL) or Priceline (PCLN) on a pullback. There are plenty of good stocks, and if we ever have an environment that supports stock picking, there should be some good pockets of action.
While Europe is obviously going to provide a nasty headwind today, I'm maintaining a generally bullish bias. In fact, a good pullback here may turn into a technical positive. We have become overextended the last few days and many stocks can use some consolidation. The key is that we hold above the trading range that was in place from early August to mid-October. The S&P 500 broke out over 1225 on Oct. 21 and it is important that it holds that level. If that support is taken out, it is going to be a major technical negative but we have quite a ways to go before it comes into play.
We'll see if the dip buyers have the nerve to jump in quickly to take advantage of this opening weakness. Unfortunately, it doesn't look like we are going to see great clarity about Italy right away. On the other hand, this setup has produced so many Europe-is-saved rallies over the last six months.
I'm inclined to be a buyer, but I'll give the bears a little room to show us what they have. I see a potentially good opportunity for the bulls, rather than the beginning of the end of the recent rally. I'll change my mind quickly if the buyers don't show some resolve, but I expect that underinvested bulls will be active.