New Highs/Unusual Volatility/What’s Next?

Today was another big day in the U.S. stock market. The NYSE composite closed at a new high on a volume surge – exactly the type of action that an investor wants to see. The NASDAQ soared even more and closed at a new 7 year high. More to the point, the stocks that GCM holds in its models jumped again, outperforming the market handily. Its hard not to be bullish right now from where I sit. My gut says we are poised to go higher but other parts of me are questioning the sanity of such a perspective.

In fact, there has been much to be concerned with over the last 2 ½ months as the market surged. Perhaps most troubling has been the series of negative divergences that have developed among key technical indicators. While the above indices are making new highs, the advance decline line has not. To the contrary, the line is below the October 12th level when the market was at the last new high and it is even further below the July 16th level when the market was at the last new high before the subprime mortgage meltdown. This suggests that the average stock is not moving higher and the pizzazz in the indices is due to the gains of a select group of stocks. As leadership narrows, a bull market is threatened.

Volume flows are out of sync on the NYSE and the NASDAQ. During the summer rally, volume was not overwhelming but it generally ebbed and flowed with the market. After the volume surge during the ensuing summer selloff, the market rose on noticeably lower volume. The lowest volume was about 3 weeks ago, at the last peak suggesting weak demand at higher prices. Then, as the market dipped in later October, volume picked up suggesting sellers were getting aggressive. As the market rose during the last week volume ebbed again – a buyers strike? Volume is the weapon of the bull and should rise with rallies (aggressive buyers) and fall on declines (an absence of buyers/weak selling). Since just the opposite has been happening, we have yet another negative divergence.

Finally, the new high/low list has been anemic. The 10 day moving average of new highs to lows has been deteriorating. As the market has just “broken out” one would expect a surge in new highs, perhaps 500 or more a day, not the 150 or so we have been seeing on average. Other factors are more subjective – tremendous volatility on a day to day basis in select “hot” stocks as well as the WCG debacle. Lots of anxiety over interest rates, credit, the China bubble, to name a few.

Yet, the indices feel like they are going higher and a breakout could carry us 15% quickly, maybe by year end or early February 2008. Ultimately we buy and sell prices, not volume or new highs or breadth. So we should respect the price action the most.

So what’s a portfolio manager to do? For me, the answer became simple – raise more cash. If the market breaks out, our list of winners (RIMM, PCU, MTW, AMX, STRA, etc.) will likely do more than their share of the lifting. If necessary we can add to existing positions or take on new ones – there is no dearth of ideas in this shop right now. But, if the negative divergences cause this potential rally to fade, that cash will help us grind through that period and make better decisions near the low. In other words, it will be better being more on the outside wishing we were in rather than being more on the inside wishing we were out.

We will continue to monitor the markets closely and hopefully continue to add meaningful gains to the already excellent year we are having. Stay tuned!

some questions answered

since the last post where the market's strength was questioned we've seen a 3% drop. normal range and on the surface not much to get excited about. but, much has been happening.

in "the big picture" on a1 of the investor's daily, yesterday's fed rate cut rumor was billed as the driver of yesterday's afternoon rally. the fed has at least one problem and its the economy - not so hot domestically. they can't let housing drag it down too much more so more rate cuts are coming. my reaction to this rumor/news is that the fed needs the stock market to replace the wealth lost in housing. that's the easy solution and one that they figure will probably work reasonably well.

however, the market signals are telling us something else. the volatility index is swinging sharply - in the last 5 days we've had 4 20% swings. that is fairly unusual and mimicks some of the trading from late july/early august. the level of subprime related writedowns are not really surprising but the recent ones from merrill and wachovia were grim reminders that there is a problem out there that has not completely gone away. a look at the money center banks (c, bac, jpm) is more depressing. these great drivers of monetary growth are not carrying their weight. c is at a new 4 year low, bac is at a new 18 month low, jpm is the champ of the group but it is underperfoming 55% of all other stocks so its hardly worth getting excited about. this is probably why the fed needs to steepen the yield curve further (thru rate cuts) so the banks can make more money and improve their weak levels of loan activity.

if the fed reinflates this mess then inflation worries will abound. so for every fed rumor that gets mentioned, the materials sector should rally. keep an eye on copper (pcu, fcx), gold (aem), and dry shippers (drys) to get a sense of how serious the inflation threat is. the dollar/euro relationship also bears watching.

at the same time, watch those winning stocks. we have a few parabolic names in the list and profit taking is tempting but it seems like the rally is a few good days from an explosive move. i think that move goes higher but anything can happen in this edgy environment. stay tuned.

more questions than answers?

today was a decent rally as the markets got back into the bullish swing. but, as ey says, the market cannot keep going up on low volume forever. it was light again today and thats troubling but the list was impressive for us.
note three tech stocks: txn, rimm, aapl, & goog. they are very representative of what's happening across the board. txn failed to make a new high in this market and lets face it - if it couldn't do it in this environment odds are it ain't happening. so that's a sale. rimm was up 93% from bottom to top in less than two months. today's rally took it up to the bottom of a small top that i think will keep a lid on things for awhile. rimm is probably not done but could use a good rest after such a move. maybe we scale back a bit but i would hold this longer and accept the correction to the 90's. aapl wasn't as strong as rimm but the last few weeks have been big for it. today it almost cleared the same type of small supply zone that i think will hold rimm back. its a little stronger right now and should keep moving higher. goog is simply amazing as it flew today while others while mucking around. a new closing high for a tech stock after yesterday's reversal is exactly what the doctor ordered. so, there you have it...weakness should be sold, strength should be bought or held with expectations of correction, break out and continued rally.
its not a bad market! enjoy the weekend.

been a while

you know something, its really easy to get used to not writing a blog every day. much easier than getting used to writing one every day! the last few months have been chaotic but having managed to survive the last 3 months, and having gone from peak to peak and then some, today brought an inside-out day on the market, or something like that. this is a technical phenomenon where major indexes reach new break-out highs and then reverse to new weekly lows. today, they mostly settled somewhere in the middle to lower end of the range. volume rose which suggests the selling was more intense than recent buying. so will tomorrow bring ornery bulls back to the table to buy aggessively and reset the peak? we have seen these self-sealing markets since 2003's breakout and they can't be counted out. since this bull market started 4+ years ago we have yet to have even a 12.5% market correction so it would not surprise me at all to see a nearly immediate reversal back up.
but, the market cannot continue to go up on low volume. pre the july peak we ran 1.5-1.6B shares a day avg volume but now its been a 1.2-1.3B daily affair at most. and then today aggressive selling hit some major air pockets. e.g. rimm was on the verge of another new high off the open when selling came in. it settled down a couple of points but around 2pm it starting falling and was down about 10 PERCENT in 15 minutes. that is not healthy action no matter how you slice it.
unless of course the self sealing market resumes. its been nice to be mostly invested but right now anything that has much deterioration is going to get kicked to some extent. we did that yesterday with a few names but our average 15% cash weighting is starting to feel a little light. let's face it - this 190 point s&p 500 rally in less than 3 months (1700 dow points) will correct. with recent big outperformance its ok to book some profit from the most extended stocks and cut losses on the weakest. while the downturn should produce an opportunity it will likely be brief and one we should scale into to make sure we get some at lower prices before the rally to new highs resumes.
or, is mr. market about to kick our butts in another of the bar-room brawl type corrections we seem destined to deal with. it would be so poetic - we finally get the sp500 and dow to set record highs on the same day and a new correction begins. i don't really advocate trading that much but i cannot stop thinking about being nimble here.
i hope to write again soon.