Will the Elephants Dance?

So the stock market has been correcting for a couple of days, and with earnings season around the corner it feels like we could be in for more of a pullback than we have seen so far in this rocket ship rally out of the basement since March. In many cases the rubber will have to meet the road in-terms of investors getting a bit of a sense of recovery as opposed to just the "less worse" news flow of recent months.

Last week we got some disappointing news on home sales and durable goods orders. Gold, which had been holding well above $1,000 an ounce, wilted back below the four figure mark, despite the weak dollar - chart here(View image). Oil which has paced this rally (in fact it bottomed out in late 2008 before the stock market) appears to have begun potentially topping out a couple of months ago - chart here (View image). Meanwhile the stock market appears to have reached a critical short-term junction, as best illustrated by the market leading NASDAQ Composite Index. You can see where I have marked up the chart here (View image).

The NASDAQ has had a great high octane rebound from the lows of last Spring (which has featured only one real pullback thus far) and it appears to be stalling out just below a key resistance level (a level where stocks traded sideways for some time and presumably many buyers during that period were stranded with losses) established when all hell broke loose in October of last year. The fact that "the NAZ" has been able to overcome the downtrend line from the markets' peak, I view as a long-term positive suggesting that the upcoming potential market softness will only be a pull back in this cyclical bull. The Dow, on the other hand, has not overcome its long-term downtrend line yet and is running into headwinds at a minor resistance level where stocks paused after their initial post-Lehman downward cascade, as opposed to at the major resistance around 11,000 - chart here (View image).

So you say "Ok Jeff, lots of squiggly lines you are trying to interpret here, but what does this all mean to me?" Let's break it down. Oil is a great barometer of world growth, it is also a commodity with a cost of production, beneath which producers won't produce (eventually deflation cures itself, because producers either stop producing voluntarily or go bust and have to stop). Oil stopped sinking when investors realized that the global economy wasn't going to zero and anticipated that OPEC would cut back on production. The commodity immediately made a bee-line for the marginal cost of production (cost for the least efficient producer to make a profit) though to be $60 - $70 a barrel. At this point demand really has to come back to give oil much more headroom, or OPEC would have to tighten even more (why would they when they are making good money at these levels and the world seems to be able to pay these prices). Gold has been in a five year basing pattern associated with the tug of war between inflationary trends (which were clear in 2006 and 2007) and the deflationary forces that were brewing below the surface and of course boiled over in the last year. The break above $1,000 coupled with the breakdown of the dollar appears to have signaled the market's belief that the U.S. will inflate it's way out of the debt crisis and that our creditors will indeed supply the fuel for us to do just that. I expect a brief re-think of this scenario in reaction to evidence of the still hurricane-like strength of the deflationary forces as we pass through the recent eye of calm. Reminders like the recent results of the shared national credit review and hometown examples of moguls laid low like Kent Swig will way on the market's complacency. In my opinion the NASDAQ has led the stock market higher due to the recognition that technology companies have better exposure to emerging markets than the average U.S. equity, as well as stronger prospects for growth, due to the "tech super-ball effect" wherein lower prices drive technology penetration (note that the hottest new market for PCs is rural China)

Meanwhile, the Dow Jones has shown some interesting divergences, with stocks like Target having made huge runs, while Wal Mart (View image) lags behind. Exxon(View image) and GE (which actually finally "broke" out a couple of weeks ago{View image}) have struggled while Goldman has run into overhead supply not far from its all time highs. However, this rally has been so pervasive that even the laggards stocks are technically positioned for a big move up. My guess is that after some corrective activity we will see the market resume it's upward trajectory, but at a more moderate pace. This because I expect the government to continue to do everything it can possibly do to keep the recovery on track, while avoiding sure deal killers like a big tax increase, major protectionism, etc. My guess is that the next phase of this bull market will be lead by the formerly lagging mega cap stocks, particularly those with a defensive tilt. So in fact we should eventually see these elephants dance....if not something is probably going wrong. Big hat tip to technician Carter Worth of Oppenheimer who alerted me to the interesting divergences among large cap stocks in contrast with the overall bullish blush of stocks but in light of the markets need to take a rest.

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