Late last week, the markets hit a pocket of turbulence on news that Dubai World requested an extension on debt payments of approximately $60 billion. The knee-jerk reaction was that stock markets tanked, the dollar rose, gold, oil, and commodities fell, and risk assets were roiled, for a day. News networks heated up and talk of a possible second wave of credit losses cascading through markets like the 1997-98 Asian Contagion was the concern du jour. Personally, I don’t think it’s much of a shock that Dubai is having some problems. I mean come on, anyone that’s watched the Discovery channel has probably seen the documentary about the creation of the Palm and World islands. Not that the place is not really neat, but it doesn’t take a genius to know that indoor ski slopes, manmade islands, and spectacular office structures may seem a tad extravagant in good times, never mind while much of the world has just suffered through the worst economic crisis since the Great Depression.
Perhaps more concerning to me than Dubai is that there are a number of technical divergences that are building within the marketplace. Some examples are that neither the Dow Transportation Index nor Small Cap stocks have kept pace with the S&P 500 Index recently, previously healthy breadth (advancing vs. declining stocks) has caught a case of halitosis as the A/D line is sagging, the number of stocks making new lows is creeping higher after a long slumber, and volume is steadily falling. We aren’t the only ones noticing these divergences – some of the most bullish analysts we follow are beginning to change the tone of their bullish commentary, with the market rally beginning to look a bit weary after its torrid rise. Add a short-term extended market to the mix and you could make a good case to simply get defensive right now.
But it’s never that simple with markets, and there are a few things keeping us from getting more defensive just yet. Liquidity in the marketplace remains buoyant, momentum is still positive, the trend of most economic data is continuing to improve, and we are coming into the season of the so-called Santa Clause rally, which is the moniker Wall Street uses to describe the historical tendency for stocks to rally at the end of the year. The bottom line is that we are diligently monitoring incoming data (as always), and our strategy remains flexible, but for the time being we are cautiously keeping portfolios positioned for neutral volatility.
Chart Source: Jim Stack, InvesTech Research
