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Break Time

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My internal indicators said I needed a break this week. And the many technical indicators I track suggested the market has been taking a break as well.

The funny thing is that when you say that the market is ready to take a break, people read that the market is about to get crunched. That is not my view, although it could happen.

Right now I'm looking at rotation vs. major market index moves. The hope coming off the March low was that once the war with Iraq was resolved, there would be a surge in spending by consumers and businesses. Obviously, if there is going to be a surge, it will be a delayed one. The hope of an immediate pick up drove stocks higher. The reality of fundamental malaise right now could prevent big upside from a broad market perspective, but structural forces could also prevent big downside.

A reversal in the dollar -- coupled with a violent countertrend spike in rates -- could kick off a structural move out of bonds into stocks. What does one focus on in an environment of slow, unsteady growth, where structural moves could be the game? Look at rotation out of sectors where prices and valuations are a little stretched and movement into those areas where earnings performance is less dependent on economic growth.

It is also important to understand that rotation doesn't necessarily equal tanking or surging. It could simply mean limited sustainable upside for some sectors and better upside for other sectors from current levels. In other words, my call for rotation out of financials doesn't mean they have to get crushed (although they could) -- it just means there are likely to be better gains elsewhere in the market. In even more other words, the risk/reward is less favorable.

My view is that those gains can happen in the more defensive areas such as the consumer staples stocks (stocks that make products that we buy no matter what, like soap) where there is a higher level of earnings predictability. This unique environment should limit extreme views because, frankly, they are unnecessary. The reality is if the market spikes higher, it would likely be a broad move, so the defensive stocks should work. If the market gets hit, the defensive stocks should go down less (or even up) relative to everything else.

On a separate note, I want to wish everyone a very safe and happy Memorial Day weekend. This is a great time to remember those who fought and those who were lost while protecting our way of life. Have a great weekend!
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No positions in stocks mentioned.
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