Small-caps in the Lead

Small-caps are leading to the upside today, reaching new rally highs as the S&P struggles to recover yesterday's close.  For the most part stocks have shrugged off the Goldman news quite well, and there have been a number of high profile stocks making huge gains (AAPL, NFLX, CMG, and PNRA just to name a few).  Despite the set back last Friday, it doesn't feel like the bulls are ready to give up the fight just yet.  If we close into strength, it's time to take that hedge off until we see some follow through on weakness. 

Stocks Are Holding Up Well Despite

Despite the best efforts of Goldman and Google to knock the market back a few steps, most stocks are holding up surprisingly well.  Pretty much all the stocks we follow are down on the day, but not to the degree you would expect given the broader market action and the intense selloff in the financial sector.  Even so, these kind of out-of-the-blue events can do some weird things with the market and the dip buyers have given us an opportunity to put on a nice hedge off the day's lows.  At this point we'd recommend hedging half your long exposure (SKK is our hedging vehicle of choice) and taking it off once the market stabilizes or regains yesterday's highs.  

What a Rally!

Although it looked like the stock market was losing steam at the end of March and on the verge of rolling over, we saw great action the past few days, pushing the markets to new highs on good volume.  This is the kind of action you love to see as a bull but unfortunately time may be running out for this leg of the rally.  Breadth looks great, most economic indicators are steadily becoming more bullish, and sentiment is still mixed -- for now.

The problem is things have finally improved enough for there to be a strong bullish argument in favor of the market.  Sure consumer and government debt is still a major problem, the job market sucks, and the jury's still out on what becomes of Greece, but that's all old news.  Investors grow numb to arguments and statistics after they've heard them day after day for months on end, and they stop weighing them as heavily in their stance on the market.  To knock this market on its ass we need to see some honest-to-god unexpected deterioration in fundamentals.  With the perma-bears splitting hairs as they pick apart this market (how else will you justify to your clients having missed out on a 13-month 85% rally?), this is an unlikely scenario.

So why is it a problem that things are finally looking up?  Because now the bears that have so stubbornly refused to participate in this market will give in and start doing some buying.  As Keynes said, the market can stay irrational longer than you can stay solvent.  Once that happens we'll likely see an initial surge as this buying power enters the market and others are drawn in by the excitement, but then who's left to continue buying?  Sentiment will swing sharply bullish and the party will be over.

This has been a wonderful rally, and as an investor who's participated in it since its early months I'm finally getting the feeling that its time to lock in the open profits and let the market take a breather for a while.  Don't sell everything prematurely, but tighten up your stops and get ready to lock in your gains.  It's been a great ride.

The chart that holds the key.  Momentum has picked up to the point that all those other arguments don't really matter.

Have a look at how strong the market internals are!  Not much room left for improvement (though it is possible to stay at these levels for quite a while).