End of year thoughts

Well the market has made a nice move higher since my last post which was not that long ago. What a difference a week makes hey? We managed to get above 1200 and then moved very quickly back to the old swing highs where we now roughly sit. Whilst the ECB did not announce any new measures they did hint that they would do what was necessary and showed this to the market by buying Irish and Portuguese bonds through their Securities Market Program on the day of the announcement. However, the European sovereign debt saga is definitely not over (will it ever be??) and personally I would expect future shocks to come as there is still no agreement on how to deal with the situation. At the end of the day some form of restructuring is going to have to take place. Expect in the interim for the ECB to start expanding it's bond buying program in the meantime. If and when Axel Weber gets in then that could all change. In other news the U.S. unemployment rate ticked up to 9.8% but this news was offset by a big spike in pending home sales. Overall the data coming out of the U.S. is improving but unemployment is not which is going to give the Fed another mandate to add even more liquidity to the system with QE3 probably sometime in the middle of next year.

As for predictions going forward, most of the historical data and statistics suggest high probabilities for further intermediate term strength (which is where I'm leaning). Seasonally we get the usual Xmas rally around this time of the year and I expect nothing different to happen this year (most traders will be on holidays so expect any big moves to come in the new year). I can see the SPX moving towards the next target of 1300 early in the new year. However in saying that there are signs that of divergences building up with internal market indicators. This last upswing since the November highs has occurred with narrowing breadth, decreasing volume, lesser number of net highs and lower cumulative ticks. All course this could all change but you would have to remain cautious without this confirmation of the current price action. Indeed this type of a divergence was prevalent towards the latter part of 2007 and culminated with the massive bear market the following year so one needs to be careful. We have had a large amount of market intervention by the Fed (POMO for instance) and other central banks and this could be what's holding the market up.

I suspect that major structural flaws in the financial system (that of over indebtedness) will only become a huge problem when all the quick fixes and solutions don't appear to work anymore. Right now we are seeing bonds selling off across the board (especially in sovereigns) and longer term interest rates rising. This will become a limiting factor as to how much more easing the central banks can do. For 2011, inflation and rising bond yields will become the big theme. Whilst right now this isn't so much of a concern as it suggests an improving global economy, it could ultimately prove to be a negative on stocks especially if unemployment remains high and we get some kind of sharp spike caused by sovereign default for example. The Chinese inflation story is also a worry as the path that they are on is clearly not sustainable. Of course I expect the stock market to discount these fundamental problems and overvalue itself just as it did with the U.S. housing market back when problems first surfaced in 2006. This is because I believe markets and their behavior are largely built on riding the trend for as long as possible, herd behavior and short-term-ism approach (especially true in today's high frequency, algorithm and robot dominated trading).