Reasons to be Cheerful

2005 started poorly, and then got worse. The year-opening
market malaise has led to a sell off that’s given the Bulls a winter chill.
Blame Oil, earnings nervousness, a tightening Fed, and a hot end to 2004 for
the recent buyers strike.

But all is not completely ugly: A few factors provide some warmth to those betting that this
market still has some upside left in it.

Despite all the teeth gnashing, the retracement of gains off
of the August lows has been relatively modest. Nasdaq gained a trough to peak
total of 441 points (1750 – 2191) for a rise of about 25%; So far, markets have
given back about 101 points (on a closing basis – 2171 – 2070). That’s less
than a 25% giveback of gains – at least
so far.

On the Dow, we ran from 9,708 to 10,867 – about a 12% gain.
So far, the give back (closing basis) is 349 points -about 30% of the rally.
The SPX gained 157.2 point (15%), and has returned a little over 42 points –
for a near 27% retracement. After a
strong move up, markets can retrace 38% or even 50% before resuming an upward

What other reasons are there to maintain a positive bias?
The year-end rally created an excess of Bullishness that needed correcting. The
sell-off accomplished that nicely. Investors become Bullish only after they
buy; too much optimism suggests everyone is already at a party where the last
man to arrive pays for the beer. By rebuilding the proverbial “Wall of Worry,”
Mr. Market creates an environment where risk gets rewarded, a necessary (but not
sufficient) component for markets to go higher.

Further, Internals continue to be only modestly negative.
Volume on most of the selling days has been on the light side – on the last
down day (1/13) we saw about 1.1B shares change hands on the Nazz, and only
1.5B shares trade on the NYSE. Up/down volume was a modestly poor 2 to 1
negative; Similarly anemic readings were seen on the Advance/Decline line (down
for the past 4 weeks);

The bottom line is that the 2004 rally stole some gains from
2005. We got ahead of ourselves last month, and the past few weeks has been a
process of working off that excess bullishness.

These factors – plus some salivation over the impact of
social security money, both on fees and the positive impact the fund flow will
have on the market – should be heartening to the Bulls. Once this consolidation
runs its course (to ~SPX 1166), the next leg is likely to be up.

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