PM: Too much pessimism?

PM Update

MARKET BEHAVIOR
Stocks bounced back and recovered all of Thursday’s losses in average volume.

MARKET SENTIMENT
The thing that concerns me is how popular it’s become to bash this rally.  It seems everyone is predicting a pullback, even bulls qualify their bullishness by saying they expect some near-term weakness.  The challenge is figuring out what this means.  Those who are harshly critical are already out and likely short. By itself that took a lot of selling pressure from the market.  The only ones left to sell are the confident and complacent holders since the weak were flushed out in the preceding volatility.

The key to figuring out where the market is headed is understanding how other traders are positioned.  When everyone is bullish, there are lots of potential sellers.  But if traders are growing weary and expecting a correction, they called it quits.  If the cautious and pessimists bailed while prices remained stable,  it is bullish because we will see a rally once the preemptive selling abates.

The other thing to consider is market can do more than just up or down.  It can go up a lot, up a little, trade sideways, pull back a little, or pullback a lot.  So far the consensus expects a modest pullback and thus becomes the least likely outcome because it is already priced in.  That leaves both ups, flat, and down a lot.  The only scenario to consider is down a lot because flat and both ups can be bought and held.  The only outcome that requires a significantly different tactic is down a lot.

The reason down a lot is still on the table is while many active traders are out, the longer viewed investors only expect a modest dip and are willing to hold through it.    The bigger selloff occurs when these longer-term holders get spooked and start selling.  This pool of institutional money is far larger than the small group of active traders already out of the market.  The one thing I struggle with is smaller moves don’t need a reason bounce around, but larger moves require a catalyst to shake the confidence and resolve of otherwise calm and collected money managers.  While the market is poised for a down a lot scenario, without a bump from an external factor, we could glide across the thin ice without falling in.

TRADING OPPORTUNITIES
Expected Outcome:
Monday will be an important day for the markets.  If bulls cannot add to today’s gains, it shows they are losing control.  This is the obvious buy point and if dip buyers fail to show, that means we’re running out of them and this rally is done.  But chances are this buy-the-dip phenomena is becoming so obvious, non-swing traders are getting in on the action and making “easy money” buying the obvious bounce.  Unfortunately for them, real money is made being one step ahead of the crowd, not two behind.  That is why I am suspicious of the sustainability of this support.  We can coast a bit higher, but if this really  is a head-and-shoulder pattern, look for a modest bounce and slide back through 1540 in coming days.

Alternate Outcome:
Without a near-term breakdown, we have to be ready for the market to continue.  Sentiment shifted against this rally and recent volatility cleared the market of weak and uncommitted holders.  With these guys out of the way, the path higher is clear.  I’ve been suspicious of this market for several weeks, but holding together like it has is impressive and shows there could be more life to this story.  I’m okay being wrong, but I refuse to stay wrong and will do a 180 if the evidence no longer supports my cautious hypothesis

INDIVIDUAL STOCKS
AAPL couldn’t hold earlier gains and is struggling to stay afloat ahead of earnings.  The good news for AAPL bulls selloff took a good chunk of downside off the table and set an even lower bar for the stock.  But buying here is clearly going against the trend and is nothing more than catching a falling knife.  The better trade is letting this stock find a bottom first.  You will be late, but the risk will dramatically reduced.  The best thing that can happen for the stock is a sharp, high-volume selloff following earnings.  This will extinguish any hope left in the stock and set the stage for new ownership to step in and ride it higher.

AMZN is struggling with the 50dma.  Not good for a stock that has come this far and has a staggering valuation.  A disappointing earnings could finally break this stock.  I wouldn’t bet against earnings, but there is a trade riding this stock lower if it breaks down.

Plan your trade; trade your plan