DOLLAR AND FROTHY SENTIMENT ARE NEW WORRIES / BARRON´S GETTING TECHNICAL

Wednesday, August 26, 2009

GETTING TECHNICAL

Dollar and Frothy Sentiment Are New Worries


By MICHAEL KAHN

There's a fine line between risk taking and risk ignoring. Bulls may be doing both.

THERE IS NO DOUBT that bull markets of any variety flick bad news away like annoying bugs. They also do not give latecomers easy entry as pullbacks are fleeting with last week's brief dip a case in point.

Whether you believe the world has been saved from financial disaster or simply think we are in a brand new bull market, it does seem that speculation is back in vogue. And that raises a red flag.

To be sure, speculation is not a bad thing, but what has popped up recently seems to be a bit overboard. Stocks left for dead such as Fannie Mae (ticker: FNM) have suddenly become the momentum stars that Internet stocks were back in the late 1990s. Indeed, an analyst at Morningstar called Fannie Mae insolvent, making its recent quadrupling in price pure speculation.

Nobody seems to know why some good -- but relatively normal -- fundamental news sent Vonage Holdings (VG), a telecommunications company and penny stock, up nearly 500% in just a few days.

Steve Hochberg, chief market analyst at Elliott Wave International, comments that most of the market's volume has been concentrated in just a handful of stocks such as Citigroup (C), Fannie Mae, American International Group (AIG) and CIT Group (CIT).

"All are de facto bankrupt and bailed out by the government," he adds. "The speculative juices are definitely back, which is typical of the end of an up-cycle."

In my Aug. 5 column, I cited Jake Bernstein's Daily Sentiment Index as showing 87% bulls among futures traders (see Getting Technical, "The Elusive Correction Is Upon Us," Aug. 5, 2009). As of late last week, it had edged up to 89%, well above the normal 60%-70% range and the most extreme reading of optimism since 2007. Traders are more optimistic than they were during a proven cyclical bull market. Hochberg cites this as another example of typical behavior near a top.

Although not always the case over time, stocks and the U.S. dollar have been inversely correlated this year: a strong dollar typically matched with weak stocks and vice versa. Right now, the greenback has started to stabilize after failing to follow through on a technical breakdown seen earlier this month.

On Aug. 3, the dollar dipped below recent support, and with a declining trendline from the March peak firmly in control, things did indeed look bleak (see Getting Technical, "The Greenback Is Broken," Aug. 3, 2009).

But after just a few days, things quietly turned around. While the bearish trendline remains intact, the dollar has already set what appears to be its first higher low in weeks. Bernstein's sentiment readings here show the percentage of bullish traders exceptionally low in single digits and that makes contrarians take note.

If the relationship between the dollar and stocks holds, then these changes in the dollar present a problem for stocks.

All of this builds yet another case for the bears. The problem is that the market has not cared about any of it for weeks. John Maynard Keynes once said, "The market can stay irrational longer than you can stay solvent."

And that is the challenge. We can attempt to call the top but, as many others and I have proved, it is a fool's task. Still, it pays to keep a ledger of both bullish and bearish evidence and change tactics when one side can no longer compete with the other.

Right now, market breadth is strong, momentum is decent, and the major indexes are still holding above early August highs and rising March trendlines. If and when any or all of these weaken and join the volume and sentiment on the bear side, then we'll finally get change bears can believe in.

Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.

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