Risk-On Running Into Resistance, Now May Not Be The Best Time To Bet The Farm

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Includes: SPY
by: Phillip L. Clark

Perceived progress on Greek sovereign debt has dominated the news for too long. However, it is back in the spotlight again as earnings season for fourth-quarter 2011 has run its course. Economic data has been improving but remains mixed; special factors must be taken into account to make the data look as good as the media makes it sound. On closer examination, the headlines could be construed in a not so positive way. Starting with industrials, much of the increase is due to auto sales and manufacturing. Housing is said to be getting better but most of the increases are due to multi-family starts; this supports the notion that more consumers are renting rather than buying.

Consumers are still spending and credit card debt is rising. Oil prices are on the move; our reserves are lower and Iran is suspending supply to Europe. Gas prices will soon follow the trend. We expect gas prices to eventually reach the $5 to $7 per gallon range.

With the exception of Brazil, the United States, and Japan, global growth has been revised lower and Europe is ignoring reality; Greece needs to leave the euro currency and perhaps others should follow suit. Actually, why not expunge the euro program and avoid a repeat performance; or agree that all participants must take the bad along with the good. This leaves everyone wondering, are stocks ready to consolidate or move higher?

Most of you know that I don't rely on insider trading as metric for measuring market direction. However, I do believe that insiders know more about their companies than the finest analysts. Our latest reading on Insider sentiment continues to decline in spite of the ongoing rally in stocks; insider selling is increasing. Whether we view insider activity as a market indicator, it is worth noting that they get it right more times than they get it wrong. At this stage, Insider pessimism is at its highest since July of 2011. In late 2010, sentiment deteriorated as the S&P 500 (NYSEARCA:SPY) rallied; insider sentiment remained bearish for nearly two quarters as the market continued to advance. But make no mistake, the broad market averages finally retraced and the correction was painful in July and August of 2011. Drawing a parallel, the equity market then traded at nearly the same level as it does today. Concerns over sovereign debt issues made new headlines every day as agencies were cutting sovereign-debt ratings and lawmakers in the U.S. acted like a bunch of pugnacious politicians over financial burdens. Now, ask yourself this, have the headlines changed? Very little, indeed! Insiders have a solid track record for selling out of their positions ahead of corrections. Perhaps they are signaling once more that now is a good time to protect profits.

Entering 2012, stocks were having their way and the bulls gave an insouciant wave to the European debt-crisis. What could possibly stand in their way at this point? The mighty Dow is headed to 15000 this year according to the prognosticators. On the other hand, the five-month old rally might be losing some of its momentum and economic data is not providing much impetus at this point. Conversely, commodities could be the next rewarding opportunity.

We recently increased our forecast for crude oil prices for 2012; West Texas Intermediate oil will average $100 this year, and will trade in a range of $70-$125. Looking into 2013, estimates for WTI will average $100 per barrel and will trade in a similar range. Our increases are based on forecasts for a stronger economy; supply growth in the U.S. (largely in unconventional shale plays); and concerns that if oil prices get too high, demand could fall. The current situation in Iran and the potential for nuclear weapons is the unpredictable wildcard. About 20% of the world's oil passes through the Strait of Hormuz, including crude oil produced in Saudi Arabia, Iran, and Kuwait. This water way is critical to the world economy. If Iran is successful in closing the Strait of Hormuz, world oil prices would be impacted, which translates to how much you pay for groceries, gas and electronics - all of which use oil in some way, whether it's part of the manufacturing or shipping process. If the consumer represents 70% of the GDP, their ability to spend could be approaching some unexpected barriers. Higher costs and little to no increase in wages is not the ideal recipe for sustaining an already weak recovery.

At approximately 30 miles wide, is it possible that Iran can actually close such an enormous opening? I doubt it, but looking at the Iranian Navy activity in and around the Strait, it is likely preparing to attack oil tankers with missiles and torpedoes from submarines. It doesn't have a realistic shot at closing the critical passage, but attacking shipments of crude will spike oil prices and gasoline prices will soon follow. The threat alone of closing the Strait of Hormuz has moved the per barrel price by more than 9% in recent weeks.

Continuing our discussion on commodities, our outlook is also bullish for gold, which averaged $1580 per ounce in 2011. Our forecast for 2012, based on expectations for a weak dollar, is $1800. From an asset allocation standpoint, we recommend that commodities account for 10% of assets. More aggressive traders might consider a much larger allocation and those who have the stomach for hard risk can dive in head first for the next 6 to 8 months.

The bottom line? Although stocks continue to show signs of shaking off recent consolidation, the age of this rally coupled with technical indicators tell us we've had a good run but the downside risk is growing higher than upside potential. Disappointing global economic data rattled investors yesterday and stocks finished modestly lower. Our MACD histogram has moved to negative territory and RSI is producing lower lows and lower highs. Our Stochastic Oscillator has been in overbought territory since the beginning of this year. The percentage of stocks trading above their 200-day moving average is now above 70%. If you think that sounds high, we saw readings above 80% last March, and April. This risk-on play is clearly leading the market and could be the base building for a break-out to new highs. Should this series deteriorate, we could be setting up for a repeat of late last summer's collapse. While no one knows how long this rally may last, now may not be the best time to bet the farm due to manifold challenges around the globe. We remain invested but not without excess cash to take advantage of a pullback or consolidation. Our most recent tactical shift called for 10% additional cash, bringing our total cash position to 30%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This information does not constitute a recommendation of any kind. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services.