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By Mike McDermott

The age-old Wall Street adage is that bull markets tend to “climb a wall of worry” and bear markets decline on a “slope of hope.”

In today’s environment, skeptical traders are finding plenty of reasons to doubt the current rally:

  • Europe’s never-ending debt crisis
  • Disparity between affluent and baseline consumers
  • Spiking oil prices which constrain growth
  • Disappointing Q1 earnings announcements.

And yet the market continues to rally as Europe kicks the can down the road, affluent consumers pick up the retail slack, and oil prices fail to affect all but the most energy-dependent sectors. It’s very interesting to note that both reported earnings and corporate guidance have been notably week during this earnings season – and yet stocks continue to advance.

A big part of the equation is the fact that traditional money managers are still playing “catch up” to their respective benchmarks. When relative performance is valued above absolute performance, and managers face the microscope of quarterly (and even monthly) performance reviews, it often doesn’t matter what a manager expects to happen in the long-run.

The mutual fund MUST keep up with the averages… So if the market rallies, investment managers simply must continue to allocate capital to higher-beta positions in order to keep moving on the treadmill.

Obviously, this game can’t last forever. Either the fundamentals have to catch up with the equity performance, OR the price action will stall out and give the bears some action to work with. As Mercenaries, we don’t have any allegiance to either side of this battle – and we can don a Red Sox jersey OR a Yankee’s jersey depending on the environment (I’ll let you figure out which side is which)

For now, our positioning is largely bullish with only a few select bear positions. The graphs below show the exposure in our Global Trend Capture service (pie chart) as well as the Mercenary Live Feed (bar graph). Since the path of least resistance is currently higher, the burden of proof rests firmly on the shoulders of the bears. Overhead resistance is still a technical concern, but until the price action reverses, we will continue to pursue bullish opportunities in an advancing market.

Below are a few of the areas on our radar this week…

Fertilizers Sprouting New Growth

It looks like a big year ahead for US farmers… According to a recent Bloomberg article, US corn production is set to hit a record this year as farmers plant the most acreage since WWII. Output is also expected to be strong for soybean and wheat crops as well.

There are a number of interesting wrinkles in the agriculture market right now. Obviously, higher production would traditionally lead to lower soft commodity prices. But low levels of inventory may help to soften the impact of robust supplies hitting the market.

Energy prices also play an important role as Middle East uncertainty causes oil prices to spike. Ethanol demand should end up being another offsetting factor to help support corn prices, and a quick survey of the PowerShares DB Agriculture Fund (NYSEARCA:DBA) reveals price action that is firming up.

Nathan O featured DBA as the Chart of the week for Global Trend Capture subscribers to watch. A bearish trendline has been broken and now trend followers are watching for a breakout from a two-month ascending wedge pattern.

In the Mercenary Live Feed, we’re currently sitting on a profitable position in Mosaic Co. (NYSE:MOS) – a phosphate fertilizer producer that has re-established a bullish pattern after declining for the majority of 2011. This week we’re set to add at least one additional fertilizer name as we build horizontal exposure in this sector.

The beauty of the fertilizer area is that we can take long positions in fundamentally attractive names that are NOT too extended on a weekly chart. Many of the momentum names have traded higher for a number of months and are vulnerable to a pullback. But the fert stocks still have plenty of room to run before hitting key overhead resistance.


Precious Metals & The Dollar

The US dollar rallied into the end of the year (based on rising concerns in Europe). But so far in 2012, dollar bears have taken leadership – resulting in a head & shoulders pattern for the greenback.

With the domestic recovery still very much an anemic and “rigged” policy experiment, it’s difficult to make a sound argument for why the dollar should stabilize. Record low interest rates and pledges to keep liquidity loose for an additional two and a half years certainly casts a shadow on the value of the currency.

As the US dollar weakens, precious metal prices become a natural beneficiary. Not only are they priced in weakening dollars (creating a natural bullish tendency), precious metal demand also picks up when traders (and consumers) start to worry about devaluation.

Last week, silver prices broke out of a short consolidation – breaching a key resistance area from Q4 2011. The Mercenary Live Feed took a long position in the iShares Silver Trust (NYSEARCA:SLV) which tends to be more speculative and volatile than a traditional gold position.

This week it will be interesting to see if SLV can put some distance between the current price and the November resistance area – with a continuation move likely to suck in a significant amount of trend following capital.

Airlines: Pressure from Higher Oil

The drama in the Middle East is once again playing havoc on oil prices. Last week, oil spiked nearly to $110 per barrel (WTI Light Crude), and the situation could continue to get worse.

A sustained rally in oil prices could eventually cripple the broad economic rebound, but for now the areas that are experiencing the most pain are industries with significant energy costs (as a portion of total expenses). Naturally, the transportation area comes to mind, with airlines reacting sharply to the higher costs.

Airline stocks as a group traded sharply lower last week – in inverse lockstep with oil prices. This week, we’re watching for entry points that allow us to take short positions in airline stocks with well-defined risk points.

Adding bearish exposure when these stocks are extended on their short-term charts only invites trouble from a relief rally. But waiting for a three-to-five day consolidation or drift gives us the chance to short a continuation move – with our risk point clearly defined above the consolidation area.

Short exposure in the transportation area will help to offset our current long positioning – decreasing the overall risk for our program. Southwest Airlines (NYSE:LUV) looks particularly attractive, trading below key moving averages.

Heading into the open, equities are poised to drop modestly due to (once again) more debt concerns for Europe. It wouldn’t be surprising to see the gap filled in early trading – and from there we will be watching to see how sentiment evolves.

Keep that risk in check, but don’t get frozen by all of the conflicting headlines. Use the price action as your key barometer and trade ‘em well this week!

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here: http://mercenarytrader.com/legal/

Source: View From The Turret: Climbing The Wall Of Worry