Thursday, December 2, 2010

Climbing a wall of worry

It is always instructive to see how markets react to events. Right now, traders are focusing on the positives in the market and ignoring the negatives, for now.

Mark Hulbert made a couple of important points this week. First, TrimTabs reported that the long fund inflow by fund investors into bond funds may be over. Net flows into bond funds turned negative last week. The rolling 3-month correlation of daily returns between SPY, as a proxy for stocks, and AGG, as a proxy for bonds, is negative and has varied between -0.1 and -0.5 in 2010. With fund flows into bond funds going negative, could they more likely to buy stocks?
Hulbert also reported investor sentiment has pulled back from bullish extremes to a more neutral reading after a minor correction. These sentiment readings are supportive of higher equity prices.
More importantly, the financial sector of the stock market outperformed on Monday and Tuesday when the markets hiccupped over fears of an Irish contagion spreading to the other peripheral eurozone countries. The chart below shows the performance of the financials relative to the S+P 500. The news that Ireland had to be rescued by her EU partners and that WikiLeaks announced that the next set of paper dump “would target a major bank” should have sent the financials reeling. Instead, they outperformed.

This suggests to my inner trader that the markets are washed out and the path of least resistance is up in the near term.

1 comment:

Michele said...

An excellent and succinct analysis. I have to agree. On a purely technical basis, this was the week that we finally left the Dow's 11,000-11,000 trading range behind and the weekly stochastic indicator has formed a bullish crossover. I'm thinking we'll see higher next week before we see lower.