The (market) spirits are willing, but the fundamentals are weak

Recently Barrons asked the question: “Do you believe in technicals or fundamentals?” The article pointed out that while the technical picture looks bullish, the fundamentals remain weak and caution is warranted.

I agree that the technical picture looks quite positive as the bulls seem to have regained their footing. On the other hand, respected investors and analysts such as John Hussman to David Rosenberg have been warning about the deteriorating economic backdrop.

The price of economically sensitive Dr. Copper tells the story of improving technical picture. As the accompanying chart shows, trend following models experienced a “dark cross” (circled), which point to a downtrend when the shorter 50-day moving average crossed below the longer 200-day moving average. However, copper prices have rallied significantly since that event, which points to further short-term price improvement.

On the other hand, Gluskin Sheff chief economist David Rosenberg wrote on July 27, 2010 (free registration required) that “the technical picture has improved. The data have really been unimpressive even if not horrendous. And I think we have the potential for a lot of disappointments in earnings to come as the plays on ‘domestic demand’ are in the offing.”

SocGen strategist Albert Edwards likens the current situation to Japan’s Lost Decade(s):

We are at the most dangerous stage in the Ice Age – the ‘post-bubble cycle’. For although it is clear that leading indicators have turned downwards, the choir of sell-side sirens is singing its song of reassurance. The lesson from Japan was that once the cyclical rally is over, any downturn in the leading indicators should find you stuffing beeswax in your ears to block out that lilting melody so as to avoid the jagged rocks of recession.

In the end, it depends on one’s time horizon and risk tolerance. My inner investor remains extremely cautious and looks for market strength to lighten up positions. My inner trader, on the other hand, tells me to go with the flow and stay on the bullish momentum train.