Bulls in Control, But It’s Not Clear Sailing Ahead

 market sentimentWith February in the books, the stock rally over the first two months of the year and especially in January has been more substantial than I expected. I was thinking of 1,400 for the S&P 500 if everything worked out, but with 10 months left in the year, the index is a mere 28 points from 1,400 and at its highest levels since 2008. The blue-chips Dow Jones Industrial Average closed above 13,000 on Tuesday—the first time it has been done since 2008—and is within 1,160 points of its high of 14,164.53 on October 9, 2007.

Tech and small-cap stocks continue to lead the broader market similar to what we saw in 2010 when the NASDAQ and Russell 2000 surged 16.88% and 25.28%, respectively. The NASDAQ is already up 14.62% as of the close of Tuesday and will likely take a run at bettering its 2010 results. Small-caps have more room to advance to match the index’s performance of 2010.

With the upward stock rally in stocks, we are again beginning to see euphoric comments from the press talking about the stock rally moving towards the historical highs.

While the market sentiment continues to be bullish, with the new-high/new-low ratio displaying a bullish reading in each of the last 30 straight sessions dating back to January 17, I doubt the stock rally will continue to advance higher at the current rate.

After a blistering January, February has shown some stalling, with the stock rally facing more upper resistance on the charts. I expect this to continue.

A look at the technical picture shows an overextended rally that is technically overbought and vulnerable to profit-taking. The bias points to higher gains, but the lack of strong trading volume is indicating a red flag and the absence of underlying strength.

The bearish divergence between price and volume is important and indicates uneasiness in the stock rally. Take a look at the volume of the NASDAQ. In the first two months of this year, there were only three sessions with over two million shares traded, so this doesn’t reflect strong confidence in the stock rally and mass market participation.

Of course, some would also argue that if traders and investors came back into the market when the risk declines, there could be a massive drive for the stock rally. This is true, which really makes this current market difficult to play.

You don’t want to exit too early; but, at the same time, you also don’t want to be left with big losses if the stock rally fizzles out in a market correction.

The key is to take some profits along the way, but also make sure you have some put option hedges set in place in case stocks do reverse course.

If you want to know what stocks may be ready for a run, you want to monitor what the professional money is doing. You can read my take in Making the Best Investments: Should You Follow the Pro Money?