Rev Shark:
Amid Strange Market Conditions, Stay Reactive
12/28/2005 9:17 AM EST
"When the heart is converted, the purse is inverted."
-- Author unknown
As we count down the final days of trading in 2005, we are faced with a couple of very clear negatives but also some interesting positives. Yesterday there was plenty of talk about the inverted yield curve.
The conventional belief is that when short-term rates exceed long-term yields, we are heading for a recession. When investors are willing to tie up their money for longer periods of time without a premium, they must be worried about the health of the economy, and quite often those worries prove correct.
There are some who will dispute the correlation between an inverted yield curve and a recession, and given that we have had a very flat yield curve for a long time, we have to wonder if some minor moves yesterday really have changed the big picture. The weakness of the dollar this morning against the euro also throws into question the issue of the negativity of an inverted yield curve. Nonetheless, this is an issue that can't be totally ignored. It has been problematic in the past at certain times and may well be again.
The other negative lurking about is that very high level of bullishness we have out there. Much bullishness is good when there is untapped buying power out there, but we have seen cash outflows recently, and there may not be the sort of buying power we'd like to see to drive this market.
When the bulls are all converted and the yield curve is inverted, we need to raise our levels of defense and at least be on guard for the continuation of the troubling selling we saw yesterday.
But all is not totally lost. We are now entering some of the historically most positive days of the year, and to make the setup even better, we are oversold on a short-term basis. The selling yesterday was really quite ugly and did a good job of scaring out some weak holders and taking many stocks back down to support levels. The market has done nothing in December, so we certainly aren't extended at this point.
I feel quite strongly that the selling yesterday was due in large part to many investors remembering the weakness last January and selling in anticipation of a similar scenario once again. Keep in mind also that trading is thin and that we are much more likely to be pushed around randomly. The losses yesterday still hurt, but there is a great likelihood that when they take place on light volume, they may be reversed.
It is very tricky trading out there right now, and the most dangerous thing you can do right now is to be overly bullish or bearish. Trying to predict how things will play out as we wrap up the year is a very difficult task, so a more reactive approach is probably warranted.
We have a slight recovery in the early going. Overseas markets are mostly up, as are gold and oil.