Conditions Appear Almost Too Good. Here’s Why That’s Worrisome

• December 20, 2004
• Chris Curran

The major indexes achieved solid gains for the week,
as the SP 500 and the NASDAQ Composite were both able to record new highs for
the year.  As always, the “talking heads” gave all sorts of reasons for the
gains, such as merger announcements, strong earnings reports and well-received
guidance from the Fed.  But more than likely, it was seasonal forces again
driving stocks higher.  Sellers have simply moved out of the way, while many
fund managers have little choice but to chase stocks higher ahead of year-end. 
Homebuilding shares were the standout group to the upside, thanks to bullish
guidance by Lennar.  On the other side, Drug names continued to under-perform
due to negative news from certain bellwether companies such as Pfizer.

The
December SP 500 futures closed out the week with a gain of +6.50 of points,
while the Dow futures slipped -20 points.  On a weekly basis, the ES posted a
shooting star and still leaves its bearish Butterfly pattern unconfirmed.  The
contract needs to come off last week’s low, otherwise a consolidation around the
D leg bides time and gives a better chance of a continuation.  Looking at the
daily chart, the ES posted a market structure high and is still holding above
its 10-day MA.  The YM negated last week’s doji, but was still turned back at
its Feb. high to post a daily spinning top and market structure high. 
For you daily 3-Line
Break followers, the YM and ES both remain long with Break Prices of 10657 and
1191.75 respectively. 
In the small caps, the ER2 posted a weekly gravestone and
couldn’t confirm last week’s hanging man, leaving its bearish Butterfly
unconfirmed.

                   

The U.S.
Dollar posted an inside week as it consolidated some of last week’s gains, and
could find a bid if the weekly bearish Butterfly on the March Euro is
confirmed.  The 10-yr note (ZN) formed a weekly spinning top and market
structure high after posting a hammer off of its 20-day MA.  The Semiconductor
Index (SOX) posted an inside week to close at its lows, and still looks ready to
break its bear flag.

Market
internals have confirmed the recent gains, and the major indexes have done an
excellent job of working off their excess through the use of time.  Meanwhile,
both interest rates and inflation remain low, which is an ideal backdrop for
equities to perform well.  In many respects, conditions appear almost too
good, which is always worrisome.  When all looks well, market players often act
complacent.  This complacency can be seen in indicators such as the Investors
Intelligence Sentiment Poll, the P/C Ratio, and the Volatility Index (VIX).  All
3 are suggesting there is very little fear in the market at these lofty levels,
which, from a contrarian standpoint, is bearish.  None of these indicators are
perfect timing tools.  However, when all are suggesting the same thing, it does
indicate that things are becoming much too lopsided in one direction.  With just
9 mostly light-volume trading sessions left in 2004, I’m not going to alter my
bullish trading posture, but it’s critical to note that the risks associated
with the long side of the market are increasing.

Looking
ahead this week, we’ll get a pre-Christmas update on the economy when final GDP
numbers for Q3 come out on Wednesday.  Personal Income and Durable Goods numbers
will be released on Thursday, before the stock and bond markets take a breather
on Friday for Christmas Eve.             

 

 

Please feel free to email me with any questions
you might have, and have a great trading week!

Chris Curran