A Great Start but Market Cannot Hold the Gain

SUMMARY:
- A great start, but even with CAT adding to AAPL and the FOMC decision, the market cannot hold the gain.
- DJ30 brushes the post-bear market high then reverses.
- Durable Goods Orders post another solid gain.
- Jobless claims up, but with the trend lower.
- Market indicates it is at its news saturation point and readies for a test.

More good news but the market cannot push the move further and, indeed, gives back a gain.

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MARKET OVERVIEW

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It was not a great day in the stock market. It was far from Armageddon, but stocks and the indices are starting to show attributes of what we have anticipated would happen. That is a little bit of lethargy after a good run to the upside, some earnings and other news saturation, and, of course, bumping up at the 2011 highs.

This run started in November on a test of the initial move off of the October low. Good end to 2011, and it brought a great start to 2012. Good earnings along the way. Initially GOOG had a disappointing result, and it has not recovered from that. It was followed up immediately by IBM, INTC, and MSFT to name three big names. They performed well and the market continued to move higher. Economic news continued to improve, and then we had a lessening of the worry about Europe. There seems to be an idea that Europe has things more under control, and that has helped move the market higher. While it may be a gut feeling with people thinking things are better, they actually are. The dollar LIBOR has dropped from 0.58, the high on the move. Remember it started way back at 0.2 a long time ago. It dropped from 0.58 down to 0.57, and then it hit 0.56 for a week. Now it is down to 0.55, hitting that for the first time again on the way down on Thursday. Things are improving and the market has done remarkably well.

Then along comes AAPL. It produced one of the best earnings reports anyone ever remembers seeing, and it blasted to the upside. But even with that move, it could not keep the market higher on Wednesday. That belonged to the Fed saying we will not only have easy money, but we will extend it another year and a half more than anticipated. That bolstered the market. But even that did not do it until Bernanke said he was still worried about the economy and that the Fed stood ready with QE3 if it turned out to be necessary. The fed has our back, and that rallied stocks. They did quite well on Wednesday.

Then we came to Thursday, and it looked good, too. Futures were up, stocks were trading higher premarket. We had great earnings from CAT, and it enjoyed a nice day. CAT is instructive in itself. It gapped to the upside after an excellent move to the upside from roughly 88-110. What a move by CAT. Then it gapped even higher on the news. But it had a hard time holding the gains. It rallied right up to some prior resistance from July 2011 and back to March and April. Basically the market peaks I was talking about with the indices. There it reversed intraday, showing this doji. This could be an island reversal if CAT gaps to the downside. Those occur at extremes, whether way down at the bottom after a long, hard selloff, or a solid run to the upside. That is what we may be seeing here. Looking back, you can see a small island reversal back in late April and early May. It did not do much damage, but it started the move lower. This was the zenith of AAPL’s recovery, and then it traded lower down to the June low. That is the way things work with these island reversals after a long run. Looking before that one in April, you can see a pullback. It was not huge, but it was two and a half weeks. A gap lower, a reversal, a gap higher. An island reversal that led to a nice run. That is very instructive.

This action does not say it is definitely going to happen, but it does tell us to be ready. We got a lot of good movement ahead of earnings. We got a lot of great moves with earnings because CAT beat on the top line, the bottom line, and it raised 2012 guidance. It finished up but could not hold the gain. If it gaps lower, that could bring a selling round to CAT. That is not something we have been ignoring. All along we have been saying the indices broke over that October high and they would probably have to come back and test it. After reaching up toward the April, May, and July peaks, they may just be ready to do that.

The Dow came within a whisker of touching the post-bear market high hit in early May. Everyone thought it would take it out. It looked good with the morning action, as if it could easily have that in the bag. But it could not hold the move and it reversed. Not as dramatic as CAT, but the action is the same. A rally to the upside, and there you have your doji. There could be a pullback ahead. We had a doji at the April and May peak that led to some selling. It is at a key resistance point. It bumped into those twin peaks from July for sure, and it is showing a doji and having a bit of trouble. Again this is nothing that we have not anticipated. We knew there would have to be some selling after this great run. It was just a question of when it would happen. Looks like it may be happening now.

That is not going to be the end of the world; as I said, this was not Armageddon. The questions are what will we do with a pullback. Does it come back to some other interim support level as we can see from the February or April peaks? Does it come all the way to the October peak? That is not that far below the February high. That would be a very logical point for it to come back and test. It spent a week at this level after breaking back up and matching it. There is a shelf built in there that likely could act as a support level. The problem is that it is all the way down at 12,250   about a 500-point drop. That will get people puckering a bit even though it would be perfectly normal.

We saw this action in the indices. We saw this action in AAPL and CAT and other stocks. What were we doing? We stuck with the plan. We said we would be taking gain. When we saw these stocks moving up early, we started taking some gain off the table. When we saw them start to stall, we took more off the table. We took a lot if nice profit and we got rid of some more laggards. We got rid of a lot of those already, though. We are not really messing with those. We took some trailing stops here and there, we killed some before earnings. Glad we did because stocks such as JNPR, while it had pulled back nicely ahead of earnings and was set up beautifully to make a bounce, that is not what is happening after hours. It lowered its guidance and got hammered. The thing is, there are still stocks being rewarded, but it is getting to be more of an individual thing right now, and they are having hard times holding on to all of their moves.

The market is tired. It has good-news saturation. It has earnings saturation, and it is tired after a good run to the upside. We were closing positions ahead of earnings, not wanting to risk it. Not on all of them, however. Some we kept on because we have taken good gain to this point and we believe, based on the patterns, they would perform well. KLAC is one. It is bouncing nicely. Indeed, it looks to be clearing the high for the session. That could be very good news. This stock was just recently in a breakout from a new triangle. This would be excellent action for it to continue the move. But we cannot be too enamored with that because it still has to hold it. That is the problem right now. You can grab something, but hanging onto it is the hard part with the market as it is now.

I want to reiterate that this is nothing nefarious other than the fact that it will be a pullback. As discussed last weekend, we have to see what kind of pullback we will get. There is kind of a triple action as it comes back to test the October peak. Does the hold, bounce off of that level, regroup, and make a breakout? Does it hold and move laterally for several weeks before trying? Or does it roll back below that into the prior range   or, worse, tank? Things would have to devolve considerably for the market to break lower. Again, that does not mean it will not happen, but there is just no indication of that right now other than the Fed perhaps tipping a hand that it sees something bad out there by extending those low rates basically forever.

Other than that, things look pretty good. You will have to surmise at this point that we get a pullback to test the October high and maybe a bit lower, and then perhaps some lateral movement extending below these prior highs. And then setting up, basing, range trading perhaps, and then making the run back up for a breakout. Rarely does an index make the break on its first attempt to get back through. It does sometimes, but not often. This one has run a long way to get where it is, and it is winded. We anticipated the pullback. We have taken gain on the way up and today. We will continue to protect positions and the gain we have in hand as we start to look for a test and, when we get it, just how far it will go.

FRIDAY

It is the Friday after a good run and then a reversal on Thursday. We will have an advance read on the Q4 GDP. It is expected to jump up considerably from the last reading. The final Michigan Sentiment for January will be out. It is expected to nudge higher by 0.2 up to 74.2. Sentiment is rising. It may top that, and that would be great. We need good sentiment and good will toward the economy (the Christmas season is over so we can turn it back to economics).

I went through a big spiel about what the market is doing and what we have to do accordingly. That is basically how we will have to play it for now. I will not put any new plays on the report tonight; there is no point in it. We could play some downside maybe, but the stocks are not set to do that. There still in trends. I hate to be the first one to jump in on the other side unless there is a really good play that shows it wants to go down. There are some of those out there, but there is no point in getting into them on Friday. At least in my book there is no point.

We will also have to take care of current positions. We have been doing that and will continue to do so. If we can get another bounce out of this, we will take more gain off of the table. We will keep narrowing those positions down. While don’t we just dump them all? In some cases we will. We will just dump the positions if they are not performing because we do not want to ride them down. But if we have good leaders that are holding up, we will continue to give them the benefit of the doubt. We have a smaller position in them perhaps, and we will just let them hold. If we try to jump in and jump out in a narrow range, we usually end up coming out on the short end of that stick. It is often difficult to come in and pick a stock right off of a little test.

We sold off our position in HUM on Wednesday when in closed below the 20 day EMA. We figured we would pick it up on the 50 day EMA. It went down and showed a doji the next session, and it looked good. We put it back on. We said if it made another 50 day EMA test that it would hold then we would pick it up again. It was down harder on Friday, so we are going to let it go for now and see what happens. You want to make sure a test is done. Make sure it is bouncing back to the upside, but you need to give yourself enough room to where you are not just spinning your wheels and putting yourself in a worse position. We will not be jumping on anything right now. We will let the market make its consolidation   make its move, as it were   and then we will be able to pick up new positions after they set up and put in good pullbacks. And, of course, we see which way it is heading. That will be key.

For tomorrow, we will not do much with new positions. We have some already on the report that, if they show the move, we could put some money to work. But with this action, it is back to the Missouri Show Me State. We will have to see the markets actually break out or set up better after this good run. Yes, there are some patterns that look good, but overall a lot of stocks have run a long way. They are showing the same weariness that the indices are showing, and the risk/reward is not stacked as much in our favor. I do not like that. I like to have them heaped on our side. That way we have much better odds of making money.

When times get like this, a little extended, it does not mean the market is rolling over. It does not mean the move is necessarily dead. It just means that we have to be patient. Then when the market is saying “buy me” again, that is when we can move in. I hope that makes sense. Thinking differently from the crowd is what makes you money. You do not necessarily have to be a genius or even all that smart to make money in the market. You just have so think a bit differently. Everyone was buying stocks and pushing our positions higher (we bought, too, because we can get great gains like on NFLX) we already had a lot of positions in place and they were pushing our stocks up for us. The ones we have been closing lately are those we took later in the move, and they just did not make that last run. That always happens, but you never know when the run will top out for sure, so you keep buying those as they set up. Then if they do not pan out, you get out of them, such as JNPR. We got out of that today. There are some others that we did the same thing on.

We are at a time when the market looks like it will struggle a bit and consolidate. No need to push and shove, no need to get impatient. Just take care of our positions and take care of our business. When the odds are stacked in our favor either to the downside or back to the upside, then we can step in with confidence knowing that the deck is in our favor and those face cards will keep coming up.

I will see you on Friday. Have a great evening!

Jon Johnson
Stock Splits & IH Alerts, Editor
InvestmentHouse.com