Reasons to be Cheerful

Tuesday, January 18, 2005 | 12:22 PM

2005 started poorly, and then got worse. The year-opening market malaise has led to a sell off that’s given the Bulls a winter chill. Blame Oil, earnings nervousness, a tightening Fed, and a hot end to 2004 for the recent buyers strike.

But all is not completely ugly: A few factors provide some warmth to those betting that this market still has some upside left in it.

Despite all the teeth gnashing, the retracement of gains off of the August lows has been relatively modest. Nasdaq gained a trough to peak total of 441 points (1750 - 2191) for a rise of about 25%; So far, markets have given back about 101 points (on a closing basis - 2171 - 2070). That's less than a 25% giveback of gains - at least so far.

On the Dow, we ran from 9,708 to 10,867 - about a 12% gain. So far, the give back (closing basis) is 349 points -about 30% of the rally. The SPX gained 157.2 point (15%), and has returned a little over 42 points - for a near 27% retracement. After a strong move up, markets can retrace 38% or even 50% before resuming an upward climb.

What other reasons are there to maintain a positive bias? The year-end rally created an excess of Bullishness that needed correcting. The sell-off accomplished that nicely. Investors become Bullish only after they buy; too much optimism suggests everyone is already at a party where the last man to arrive pays for the beer. By rebuilding the proverbial “Wall of Worry,” Mr. Market creates an environment where risk gets rewarded, a necessary (but not sufficient) component for markets to go higher.

Further, Internals continue to be only modestly negative. Volume on most of the selling days has been on the light side - on the last down day (1/13) we saw about 1.1B shares change hands on the Nazz, and only 1.5B shares trade on the NYSE. Up/down volume was a modestly poor 2 to 1 negative; Similarly anemic readings were seen on the Advance/Decline line (down for the past 4 weeks);

The bottom line is that the 2004 rally stole some gains from 2005. We got ahead of ourselves last month, and the past few weeks has been a process of working off that excess bullishness.

These factors - plus some salivation over the impact of social security money, both on fees and the positive impact the fund flow will have on the market - should be heartening to the Bulls. Once this consolidation runs its course (to ~SPX 1166), the next leg is likely to be up.

Tuesday, January 18, 2005 | 12:22 PM | Permalink | Comments (0) | TrackBack (0)
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