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The cyclical tug of war between bulls and bears has temporarily been replaced by a different kind of war. This other war is more short term - it’s the tug of war between the technicals and the fundamentals.

Market technicians have had complete control since the new year began. This explains why the market is acting completely independent of the news. When these guys have control it can be maddening, no matter how good or bad the news is, the market refuses to react. It's like a boat out at sea that only follows GPS navigation while ignoring the objects on the radar. This strategy does not work in the long run for obvious reasons.

If you find yourself feeling overly frustrated when the market doesn’t rally on good news or when the market doesn’t go down on bad news, it’s usually because the technical traders are in control of the action.

There are a few rules to follow when these circumstances prevail:

1- Don’t change long term assumptions. Bear with me as I switch from a boating analogy to basketball. The market action of January and February would have you believe that each time you make a 3 point shot it’s actually worth zero points. Fundamental investors know that they have drained three pointer after three pointer but it is disheartening to see no impact on the scoreboard. Does this mean that we should abandon 3 point shooters (equities) and load up on low post scorers (bonds)? We want low post scoring when the game gets rough (worsening economic growth) and we want 3 point shooting when it’s running time (improving economic growth). Just because the market isn’t giving me credit for my 3 point shots in January and February is it time to abandon the strategy for the rest of the year? That would be foolish. The refs (technical traders) can only take away the points for so long. Eventually the better team (fundamental direction of the market) will win the game.

2 - Prepare for the sling shot. The prevailing cycle can only be held down for so long. When the fundamentals regain control of the market as they always do, it causes the market to soar in times of economic improvement and it causes the market to sink in times of decline.

3 - Be careful who you trust. Independent investment research firms (like ours) are the only way to go. I get a kick out of the bond guys from Pimco who get interviewed every week on CNBC and tell viewers to adapt to the ‘new normal.’ What a marketing scheme. At a time when the economic cycle is clearly telling investors to sell bonds and buy equities these guys come up with the only thing they can, which is to concede that economic growth is coming but to try and temper the enthusiasm by saying that the growth will be slower than we are used to. Are you kidding? We are recovering from the worst recession in 80 years and inventories have been reduced by the greatest amount in 60 years. The financial panic of 2008/2009 was caused by a mark to market banking regulatory requirement that has now been fixed. In such a recovery it makes sense that the ‘new normal’ would actually be a period of stronger growth than we are used to, as there is plenty of ground to make up.

Q1 2010 has brought a healthy technical correction and the technical traders still control the daily action. A fool abandons his or her long term conviction during times like these while the wise readjust to take advantage of the coming action. The fundamentals will move the market over the long run.

Disclosure: No positions

Source: Technical Control of Market Won't Last