12/03/2006

What next

Momentum in markets is cyclical. For last few months the market slowly built up momentum. The cycle started in July and accelerated in November. That is why November was one of the best month to make money as many stocks had accelerated momentum phase. Such momentum cycles are followed by corrections. During that entire momentum phase, the market was able to shrug off bad news.

While the correction plays itself out, new set of stocks start their slow march upward, they will accelerate at some point. That is why well designed momentum methods like I have talked about many times, get you in to best opportunities. Stocks which had earning surprise and earning acceleration in recent quarters are the stocks to keep an eye on, they will accelerate at some stage. After corrections/pullbacks market again set up for a push up and the dynamics repeat again as long as earnings support the move.

There are several factors at work during correction. The market reacts to data differently. Another dose of worse-than-expected economic data on Friday morning put additional pressure on the market as we kicked off the final month of the year.

There is lot of skepticism about the ability of this market to continue to run to the upside for a while now, it is normal after a move without correction. It is time to be cautious but also time to keep your flexibility hat on. There is a possibility that the market is in the process of forming a short-term top.But as long as the earning picture does not deteriorate, there is reason to be optimistic about 2007. A economic slowdown does not necessarily mean market slide, it can also be a long drawn out sideways move, which has been the characteristic of this market for over 4 years now.

The momentum cycle has coincided with several factors which give weight to a more negative outlook on the economy. There has been a rise in crude oil and other commodities, the dollar is weakening, bonds are on tear, the Fed is still hawkish about inflation. So market is presented with a classic wall of worry.

What is happening currently is sector rotation. Stocks up majorly are witnessing distribution and pullbacks. Now this is very normal phenomenon and happens all the time. No stock keeps on going up vertically (as some foolish bulls hope for)and no stock keeps going down vertically (as some bears wished for in housing stocks). Money is now flowing in to oils, metals, and gold while technology, retail and banking are witnessing some distribution.

The market are undergoing a shift in character last few weeks. When money making becomes too easy, correction is lurking around the corner. When I saw easy money in November I was ready to go in to cash. So similarly smart traders who have big gains to protect are looking for reasons to lock in profits, and that this will continue at least through the end of this year. Then again market will set itself for a further move. We might even have a brief Santa Clause rally once enough short interests builds up.

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