Last night, I made the following remark on The StockTwits Stream:
Just as everyone is becoming convinced the banks no longer matter, they will begin to again and in a big way $XLF $BAC
Since early September, the $XLF has traded in a tightening range between 14.25 and 15 even as the broader market has been grinding higher. I like buying premium on both sides here.
Similar to the indecisive (or consolidating) financial sector, the market, despite the upward bias, is sending off some mixed signals as I assess them psychologically and the action in this sector is a reflection of this indecision.
When pundits speak about the psychological aspects of the market, they are generally talking about sentiment. This is an inaccurate and overly narrow depiction of what a psychological assessment of the market is.
Psychology is not only about sentiment (or emotion) which is but one of several modes of experience. A more comprehensive psychological assessment of markets focuses on three modes of experience including sentiment (emotional), technical (behavioral) and fundamental (cognitive).
Sentiment
In one sense, market sentiment remains stubbornly moderate even in the face of a 10+% rally in the $SPX in less than 2 months. Many smart traders have been and continue to be underweight the market and have missed the run. I view the skepticism here as a net positive.
During some rallies, there is a tendency for traders who catch the move early to take profits too soon and then search in vain for a better entry, a cycle which helps to fuel higher prices.
On the other hand, the $VIX has been in a downtrend since the June spike and often regresses abruptly so there is heightened risk of a sudden even if brief correction.
Net Sentiment: Mixed to Positive
Technicals
Broad market behavior grinds higher in a 2 month uptrend and consolidates in a fashion that is more choppy than most swing traders prefer. As well, and more recently, volume has tapered.
As mentioned above, financials have not participated while the demise of their importance has been greatly exagerated. Rest assured, eventually they will matter.
At the same time though, speculative stocks including China plays are ripping higher which often represents speculation.
Net Technicals: Mixed to Positive.
Fundamentals
We can argue these all day long. Are we experiencing a recovery? Is QE2 ultimately poison? Is the job market on the cusp of improving as earnings recover? I view this as a neutral as I have no edge here whatsoever.
Taken together, I view the market with a mixed to positive bias. As such, I am taking less risk than usual here.
The one trade I do like involves getting long volatility in the banks on both sides. There is only so much further the $SPX can go without $XLF and if the banks break down they will pull the market down and display greater volatility.
