An impressive rally today with winners clearing leading over losers. Has something changed? No. In fact things are actually a bit worse. Congress has failed to pass the payroll tax cut extension into 2012 which potentially sets the economy up for about a 2% hit to GDP, nothing has been cured in the Eurozone and Greece is rapidly heading toward the proverbial “windshield”. Furthermore, it is always important to remember that 300 point rallies in the Dow have only occurred during bear markets. Combine this with the fact that this is a holiday shortened trading week leaves the inmates running the asylum on lighter than normal volume.
However, rallies like today that come out of “thin air” leave even the most confident of market traders and analysts scratching their heads a bit and second guessing themselves. What is important to note is that this rally, while impressive, failed to get the markets out of the ever compressing trading range that we have been stuck in since this summer. What is important is that whichever direction the market breaks out from this trading range will determine our next sets of action. A breakout to the upside and we will begin to increase exposure to equity risk; to the downside we increase cash and fixed income. It is really just that simple.
As we discussed in this past weekend’s missive “sometimes the best action is no action at all” which has clearly been the best advice over the last few months. Any decisions to increase or decrease market exposure have consequently turned out wrong as the market has vacillated in this compressing trend. Currently the market is overbought which leads us to believe that we still may have some more consolidation work ahead in this range over the next couple of weeks. However, the market is on a “buy” signal which gives us reason to believe, at this juncture anyway, that the markets will resolve themselves to the upside. However, don’t take that as meaning that you should increase exposure to market risks now as these signals can reverse very quickly. Our job as investors and money managers is not to try and predict the future – that is a fool’s errand. Our job is to react when the market gives us clear direction – something that has remained elusive for months now.
The markets will ultimately resolve themselves to the economic strength of the country, corporate profits and consumer behavior. Of these issues we are not confident of continued strength. However, in between now and then the markets can and generally do “remain irrational longer than you can remain solvent.” which is why we continue to reiterate that the best course of action is no action at all. This is a game of follow the leader and when a direction has been set we will follow along accordingly. Until then – relax and enjoy the holidays and be thankful that 2011 is almost at an end.