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You're A Big Bad Market

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This week we've been watching closely for signs of technical damage. Pullbacks that are benign, and therefore simply pullbacks, typically do not cause technical damage. That's one way we decide whether we're buyers of weakness or partygoers who leave while the party is still jumping. Biotechs have broken down. The BKX breaks down if it cracks 850. The XBD breaks if it cracks 520. These are some things to keep an eye on today.

Structurally, the first crack in the armor is the Bullish Percent for the Nasdaq 100. I classify this as a short-term indicator because, well, it is comprised of a mere 100 stocks. This indicator reversed down with Thursday's action and is now on defense. The percent of stocks above their 10-week moving average indicators for the Nasdaq and NYSE remain in columns of Xs but are also getting close to a reversal down.

Remember, barring sudden shocks (Asian financial crisis in 1997, Long-Term Capital, etc.) topping is a process, not an event. As a result, sector rotation can often disguise market weakness as money moves from formerly leading groups (Biotech, Hombuilders, Financials) to other groups that have not moved up as much (Defense, Consumer non-cyclicals).

As Toddo has written, just about everyone believes a final blow off will occur into the quarter end, and following the quarter the "real" down move will begin. That seems to be conventional wisdom for now, and as we know, conventional wisdom is usually wrong.

History suggests that the initial reversal down in the NYSE Bullish Percent is rarely the reversal that does the most damage to the market. As I noted, the exceptions to this are specific, event-driven catalysts. Perhaps there is an event out there waiting to serve as a catalyst this time around (Freddie Mac (FRE:NYSE), bonds, derivatives), I don't know.

I believe markets proceed in defined patterns of Denial, Recognition, and Belief. With bullish sentiment at record levels, the Denial phase of this current rally will likely be something to behold. Shaking the conviction of all those bulls out there will not occur overnight. Most often the real damage occurs when we reach the Recognition phase. That's when the exits get crowded. Until then, keep your eyes on your favorite bull and look for the Nixonian paradigm; deny, deny, deny.

No positions in stocks mentioned.

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