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Will Markets Miss Another Shot at a Healthy Correction?

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Every time they're ready to break down, they rally instead.

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My favorite Peanuts cartoon was Charlie Brown and Lucy with the football. I'm sure you all remember them: Lucy convinces Charlie Brown she'll hold the ball while he kicks it. But every time Charlie Brown runs to kick the ball, Lucy pulls it away, leaving Charlie Brown flat on his back , crying out in pain and disillusionment . Well, that's how the bears have felt since March. They've played the part of Charlie Brown while the Fed has played the part of Lucy. And the football? It's been a "normal and healthy correction" in this runaway bear-market rally.

Every time the market looks ready to break down, the football has been quickly pulled away from the bears and the market rallies. Since March, all attempted market corrections have been orderly, controlled, and "managed." Take the July 2009 small head-and-shoulder top as an example. The market completed a bearish technical pattern with a break below the 50- and 200-day moving average (DMA) -- which had bears limbering up, seeing the crash before them. Just as the bears came pounding down the field, ready to kick the hell out of that ball, Lucy pulled the ball away and the market went up -- FAST! (This type of set-up and powerful reversal is commonly called a "bear trap." ) The shorts continued to get hurt in what I call "the mother of all short-squeeze rallies." The reversal up from under the 200 and 50 DMA literally broke the back of the bears. They were left lying on that field, full of pain and disillusionment.

Fast-forward to the last couple of months leading to Fright Night Halloween Selloff. The bulls took the market higher in the worst seasonal month of September and made a cyclical bear market high in the famous crash month of October. It looked like the market would actually escape the dreaded September and October months completely unscathed. Then, in the very last week of October, the market reversed again, breaking below the 50 DMA. Unlike July, the current market is far from its 200 DMA, which leaves room for the bears to get momentum going for their next attempt to kick the ball. But will the Fed pull it away once again? Put another way (in case you're getting tired of Peanuts), IF the bears succeed in pushing the market down, will the Fed push it back up with some new bailout, stimulus package, or market reform?

Bears Seeking Redemption

If the S&P closes below 1018, the bears will feel confident the tables have finally turned. They'll see downward potential of over 100 S&P points to the rising 200 DMA as their redemption. But they'll be patient. The bears have been burned before shorting weakness. They won't let that happen again. There are clear signs of another top, but the Bears know how the invisible hand of the Fed keeps corrections orderly. Plus, hot money waits on the sidelines to enter the market on all corrections. The bears also know the bulls anticipate a strong year-end rally as the stock market enters its two seasonally super-bullish months. The mantra now for nearly everyone, bulls and bears alike, is "buy the weakness and sell the rallies." The "sell rallies" part of the mantra is most important because the bulls have so much confidence in "all the liquidity" sloshing around the globe to keep markets rising.


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The mutual-fund managers who have lagged in performance will see these next two months as their opportunity to catch up and close the year on a positive note. The bears see it completely opposite. Just as in November 2007, the bears view this "buy the dip" into the seasonally strong period as a bull trap that will suck the very last dollar off the sidelines and into the market. The bears want the last sidelined buyer and "small spec" short sitting on the sidelines before they position for a major drop in the market. The bears believe all big rally days are their opportunity to short, and the next market plunge as their big opportunity to finish their year on a strong note. The bears keep repeating, like a mantra, "cover the dips, short the rallies; remember the November 2007 bull trap." (See October 2007 Shows Us How This Rally Ends.)

"Managers are closing their eyes and plugging their nose and buying."
-- NYSE floor trader

Mutual fund managers "know" stocks are hyped up and unattractively valued. But buying stocks is better than losing their jobs. So managers plugged their nose, closed their eyes, and jumped into the fully invested pool. Mutual fund cash levels are now at the same low levels as in October 2007 -- right before this great bear market began. Here's how the bears see it: With 5-10% gains possible to the upside and five times that (or more) risk to the downside, mutual fund managers are trying to pick up pennies in the middle of a busy highway. These Johnny-come-lately managers need to pick up some extra returns prior to year-end. They figure the risk of potentially getting their shareholders flattened is worth the reward of keeping their jobs.

Short-Term Gain for Long-Term Pain

Meanwhile, Congress and the Federal Reserve think of more ways to temporarily stimulate the weakened economy (see Dear Mr. Bernanke, Try This). The bears call it Washington's "short-term gain for long-term pain" fiscal and monetary strategy. The bears want the government to keep their hands off and let the free market take prices to where they belong -- a painful cleansing process. The bulls are banking on the fact that those in power will do all they can to put the pain off for another day. Market bulls and real estate agents are both praying for a new Cash for Clunkers-like program to slow the real estate depression. The bulls are banking on Washington to prop up overvalued homes and stocks and to implement additional giant stimulus injections to bring the consumer back to life.

Deflation Ravaging the Nation

The bears keep eying the United States' increasing mountain of debt, which is threatening our country's economic security. Worse yet, many believe when the Fed creates its final stimulus package, the lava flow of deflation will begin anew and ravage this great nation. The government will continue to throw money into a black financial hole. The world will watch as the dollars simply evaporate into this hot molten lava flow of deflation. This insanity must stop in Washington before the world wakes up to find that Moody's has either downgraded or placed the debt of the United States on credit watch. For those who think this can't happen, go to the US Debt Clock website and watch for a few quake-in-your-boots minutes.

The Lucy/market bears can feel the ball in their hands, fingers stretched along the laces. They know what's right; they know what they should do. But in their hearts, they're dying to invite the ever-optimistic Charlie Brown/bulls to have a go at it.

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No positions in stocks mentioned.
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