What Happens Next? Embracing the Bull

 |  Includes: DIA, QQQ, SPY
by: Sean Hannon

What happens next? A simple, yet important question, these three words occupy investors’ thoughts. Midway through a week which has seen the Republicans reclaim control of the House of Representatives (yet fail to take control of the Senate) and the Federal Reserve (Fed) unveil its intentions of pushing $600 billion into the financial markets, investors have seen stock prices rally an impressive 1.2%.

With such powerful catalysts having delivered profits, attention turns to the future. Do recent gains represent a peak that cannot be surmounted? Can momentum push prices perpetually higher? Is now the time to sell or is it better to increase our risk exposure?

All are important questions that can only be answered with the benefit of time. However, time we do not have. Academics can rely upon hindsight to validate ideas, but investors must act now and receive the consequences later.

Although a perfect forecasting process does not exist, different analytical tools can help. Among my favorite is confirmations. When multiple markets confirm one another, it shows long term investors are interested in owning stocks as increasing global demand improves business prospects. Conversely, selective, limited market gains demonstrate short term traders dominate with portfolio being flipped for quick profits. Absent sustainable demand, stock prices can retreat as quickly as they rallied.

The current environment is mixed. Of the 14 international markets I track, eight have reached new 2010 highs during the past two weeks with three others an average of 2% from a new peak.
When discussing subsets of data reaching landmarks at differing times, we risk becoming entrapped in minutia that obscures the larger picture. However, I believe it is important. By maintaining a set discipline, we establish buy and sell triggers that eliminate emotions and allow for quick, rationale decisions. Since there will always be a reason to execute a trade or not, formulated triggers help eliminate the tendency of making the worst possible trade at the worst possible time.

For me, the picture has become clear. The Dow Jones Transportation Average (Transports) and NASDAQ reached 2010 highs on November 2, but those highs were not confirmed by any other U.S. market. However, one additional day brought needed clarity. With the Transports and NASDAQ closing at new 2010 peaks today, they have been joined by a new 2010 peak for the Dow Jones Industrial Average (Dow). While I would like to see small-cap stocks and the broad-based S&P 500 join the confirmation parade, I judge the trio of new highs as an indication that the bull market is alive.

With prices pointing higher, we should remain long and limit our short positions. Powerful momentum has driven this market higher in recent months and will do so in the near future.

Not a fan of chasing an extended the market, the trend is higher. Those who search for value, hedge risks, and capitalize on what the markets provide will do very well over the coming weeks.