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The Twilight Zone


As I drove in this morning, I was again reminded of why it is so important not to be influenced by what you hear on the radio or TV regarding the financial markets. Remember just one week ago just about everyone was abuzz about how good things were beginning to shape up, especially for Technology and Telecommunication's stocks. Didn't Intel (INTC) suggest that fundamentals in the sector were improving? Then after a few days of what could only be considered profit taking after a seven week run, we hear that stocks fell back because investors were concerned that the corporate profit growth was beginning to wane.

Well no kiddin'! If things were looking dramatically better fundamentally, odds are that the Fed would not have reduced rates by half a percent in early November. The point is that the rally off the low in October was never about the fundamentals. In my view, the gains came from a structural shift among funds that had become overly exposed to bonds and under exposed to equities and therefore sold bonds to buy stocks (asset allocation shift), fund managers who were chasing "high beta" stocks in order to improve performance relative to the major market indices and short covering from those that had bet against the market and didn't want to give back profits. None of these factors had anything to do with the economy or valuations.

The problem was that people involved with the market or reporting on it couldn't accept such a simple explanation. The surge "had to" mean that the fundamentals were turning and would ultimately show dramatic improvement. This is what I refer to as the perception trade. The only thing that suggests the perception trade is over is when the market loses its momentum and traders need a reason to be a buyer other than "because stocks are moving up."

In the beginning of last week, I believed that the perception trade was over and that the market was entering the twilight zone trade where buyers and sellers were in equilibrium. In the twilight zone, one cannot prove or disprove anything about next year's fundamentals. Even in the current quarter, we are far enough away from the evil quarterly pre-announcement season to keep aggressive sellers at bay, yet close enough to make many not want to start building positions.

In the twilight zone, the best thing to do is the hardest thing to do - wait for real evidence and exhibit patience. In this zone, try to take advantage of market opportunities as they present themselves vs. trying to force opportunities to happen. At times like this, I believe it is more important to listen to the market instead of telling it what to do - because frankly, it doesn't care what my opinion is!
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