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The morning after



What a year. Simply annualize the gain from the first trading session of the year and call it a day. The major market indices jumped by over 3% in the first trading session of the year. As traders and investors entered the first session of the year, JP Morgan (JPM) was halted - news pending, North Korea was rattling their sabers and another "key" economic number (the ISM Index) was coming out a half hour into the session. I was sitting in the Bloomberg Radio studio and remember thinking that the JPM news couldn't be good (it is pre-announcement season after all), the geo-political environment couldn't allow any aggressive buying and given recent economic releases how could the ISM number surprise to the upside. My next thought was that these negatives were too easy to think of.

Such was the tape - ripe for an oversold rally. The funny thing was that on all three fronts, news was better than expected. JPM announce a settlement, the ISM number blew away expectations and the President talked diplomacy vs. military regarding North Korea. Now that there it has started, what comes next? My best guess is that the jump continues until the indices retest their early December highs. That would roughly be about 3-4% more upside in the S&P 500 from current levels and would likely resolve the near-term oversold condition in the market. In fact, there is potential for the indices to marginally break through their early December highs like they did last year, but again, that kind of move would come from an intermediate-term picture that has lost momentum and would likely prove to be unsustainable, especially given the intermediate-term downtrend.

Exhibit 1 - A little more upside until SPX resolves oversold condition

Exhibit 2 - SPX bouncing but remains in downtrend, has lost momentum and needs to get oversold

The intermediate-term condition doesn't necessarily mean that stocks have to tank once the equity markets finish bouncing (while that could happen), it simply means that further upside becomes very difficult as those who bought near the early December highs start selling as they approach breakeven. In English, psychology meets supply. That is all we have to look at right now. This has been a market where flexibility is more important than to the participants of Cirque du Soleil.

Right now there is a good deal of skepticism toward this rally, which likely means there is a little more to go. The first step in playing it out would be to get the major indices out of oversold and closer to overbought. As Exhibit 1 shows, that isn't yet the case yet, but soon could be if the markets do retest early December levels.

No positions in stocks mentioned.
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