Don't Get Psyched Out

 | Dec 08, 2011 | 8:54 AM EST  | Comments
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"Hold your dog in readiness before you start the hare." --Proverb

After a couple of days of choppy action, the S&P 500 has worked off some of its overbought tendencies and is in good shape for a breakout attempt above the 200-day simple moving average at 1264. If we clear that, it's clear sailing to 1275 and the October highs. It's a promising technical setup, and with the chances of positive end-of-year seasonality, there's good reason to be optimistic about upside.

What presents a challenge is the psychology at work. Foremost, the steady flow of headlines out of Europe. The European Central Bank just cut rates, as expected, and we are seeing little reaction to that. But it's the European summit over the next few days that will be the main focus. This is the tenth such joint meeting to deal with European strife and, so far, these meetings have failed to produce any lasting positive news for the market. In fact, we have sold off following every meeting. What has boosted Europe are the coordinated moves and some of the rumors that were surprises and not anticipated. Meetings are a sideshow, for the most part.

Given how much we have run over the past two weeks, the high of expectations for this summit and the track record of subsequent softness, the bears are definitely in sell-the-news mode. What may bolster that tendency is that it has been suicidal to jump in front of European news. We gap up on every headline and you know there are more headlines coming. Why fight it? If you really want to fade strength, wait for the news to hit, and then start looking for dark-side plays.

Another interesting psychological aspect is that we have a market that has made a tremendously strong move, but rather than euphoria and bullishness, we still have many underinvested bulls trying to make up performance. This has not been a very beloved rally. Volume has been mediocre, all gains have occurred overnight, and there has been little leadership other than oils and a few other things here and there. It is surprisingly sedate sentiment despite very impressive action. 

What makes the dour mood even more surprising is that we have high-visibility technicians, particularly Tom DeMark, calling for a sharp end-of-year move, and we have good conditions in place as well. Europe is probably the biggest obstacle, but hopefully it will be a little less of an issue after the news from this summit meeting emerges.

There are of lot of reasons to like this market technically and psychologically, but the focus on Europe is hurting clarity. My thesis is to look for some sort of sell-the-news reaction to Europe that gives us a buyable pullback. I'd really like to see some sort of shake to reset a few things, and Europe may be the excuse we need.

In the short term, we are on hold until this European news flow slows, but down to flat action is a positive in my estimation. I'll be looking for some buys.

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