The Breakthrough

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MARKET WRAP UP 09/20/10

In his book, “The Winner Within,” legendary basketball coach Pat Riley describes a significant breakthrough as a positive thunderbolt. Riley includes some indications that a major breakthrough is about to happen include: feelings of frustration because of hard work not being rewarded with success, deep loneliness, a recognition that a core healing must take place, healthy introspection, and prior instances of “choking” when faced with similar challenges. When viewing Riley’s book through the lens of the stock market, today had all of the classic signs of a breakthrough.

First and foremost, the S&P 500 blasted through the key multi-month resistance level at 1131, to close up 1.52% to 1142. Breadth was impressive, as many stocks broke higher after the end of last week’s benign consolidation. The small cap index was by far the best performer today, as traders have embraced risk appetite in a convincing manner. As I discussed over the weekend, once we saw a move above 1131, many bears covered their shorts in the face of a break above an obvious resistance level that had held throughout the past several months.

Despite several measures indicating that we are becoming overbought, I believe we can continue to move higher in the coming days. Moves of the magnitude we have seen over the past several weeks often catch market players by surprise. After a grinding trading range since May, the market digested many of the bad headlines this summer without entering official bear market territory, as we never fell 20% from of the April highs. Not only have we seen leading stocks, such as $AAPL and $FCX, go parabolic over the past few weeks, but many other stocks are setting up behind them as well, building bases and breaking higher.

Indeed, the stage is set to test prior key levels, starting with 1150.

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Part of the reason why the market can keep going higher is because so many market players doubt the veracity of the rally. Many traders have resorted to acting as though they are in a 20 student undergraduate liberal arts class. They go around the room, raising their hands when their beatnik adjuncts ask them how they feel about the market.

In response, the undergads say things like, “This market feels off to me. My feelings and emotions are out of touch with it, ” or “Something just isn’t right to me. Like, OMG, It really feels shady and random and sketchy. I need to call my life coach and fix this major problem in my life because of this evil market.”

Folks, have some goddamned pride. You should be focused on rigorous analysis of the markets, and that should dictate your bias and portfolio allocations. Your feelings, if anything, should act as a contrary indicator. Better yet, do not play that game. Perhaps these “feelings” are nothing more than your breakfast sitting in your stomach the wrong way. Thankfully, I have never heard one of my loyal readers say something like that (because my readers are, pound for pound, as intelligent as any traders anywhere).

In my video over the weekend, I talked about the importance of being as objective as possible in your analysis. While we were consolidating last week, my strategy was to play along on the long side, but with a big cash position as a buttress because I felt the risk of trying to anticipate a major breakout was too high to go all-in long. Today, we have indeed broken out above 1131, and because that level was so significant over the past several months, as soon as we broke above it we saw a “woosh” effect up to 1142. How much higher can the market go? Well, the first target would be 1150, the key resistance area dating back to at least January. After that, look for 1170, which marked the tough resistance that turned the market away after the flash crash.

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With the bears trapped in the move above 1131 on the S&P 500, I believe it is now correct to look for trashy, high beta stocks over the next few days. I am not talking weeks here, just a few days to rip the shorts who are acquiescing to the melt-up. Moreover, the low grade stocks will be playing catch-up to the broad market.

In other words, it is now acceptable to act trashy. So, go ahead and take a drive out to the Roosevelt Field Mall on Long Island, and start talking trash to random people minding their own business. Trashy is in. Haven’t you heard?

I bought a full position in trash du jour, $RDN. All trades are timestamped inside The PPT.

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TOTAL PORTFOLIO:

EQUITIES: 42%

• LONG: 42% ($ATPG $BTU $NYT $RDN $VMW)

CASH: 58%

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I made two trades, thus far today:

• I sold out of $CREE (1/2 position) for a small loss.
• I bought a full position in $BTU, based on the chart below.

All trades are timestmaped inside The PPT.

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TOTAL PORTFOLIO:

EQUITIES: 34%

• LONG: 34% ($ATPG $BTU $NYT $VMW)

CASH: 66%

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I believe this is one of those situations in the market where it may not serve you well to think in terms of everything melting up or down across the board. Just as we have become accustomed to potent correlations across a variety of asset classes, my analysis coming into this week leads me to submit to you the idea that the broad indices may not do much this week, either way.

Instead, we could easily see a sector rotation out of technology and into the industrial/material/energy complex. First, the Nasdaq ETF, seen below, should illustrate why I am reticent to just cavalierly toss out a bunch of long setups to you for the upcoming week.

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Despite the temptation to extrapolate that the entire market is an easy short here, given the chart above, to do so would ignore the bases being built in the energy and materials. I will be keeping a close eye early this week on whether my rotation theory comes to fruition. If I see glimpses of it on Monday and Tuesday, then I will be quick to exit my technology plays and look at some key names in the sectors I mentioned above. I already own $ATPG, and that looks to be as good a setup as I can find for this week.

While many stocks became too extended last week, the energy and steel names, for example, consolidated nicely and look to be scalloping out multi-month bases.

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If the video below is too small to watch here on iBC, then you can just double-click the screen and watch it on YouTube.

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[youtube:http://www.youtube.com/watch?v=qc2OWHS8lv8 450 300]r

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