Stocks Keep Rallying

The run for the US market continued yesterday as the S&P 500 closed at 1351. The SPX has a 7.5% gain for the year which is a great start to the year. You can still be a bear and acknowledge it is a great start to the year for equity prices. If you are a bull you probably think this will continue and if you are a bear you might predict it will end today.

As a quick note I really dislike assigning animal caricatures to market cycles but there is a certain economy of words that is convenient.

My thesis for 2012 has been that there would be a range busting rally that will then mostly retrace. So far this is not wrong but it is worth throwing out a couple of reminders about how markets tend to work. This is an important communication to clients and hopefully non clients can find some utility as well.

If my theory of a range buster turns out to be precisely correct then we might see SPX 1570 by summer time. That level would would represent a 25% rise from the year end figure of 1257--again my thought is big and fast rally that then retraces a lot. Again, this will be right or it will be wrong but if it does go to 1500 or 1550 or even 1600 in such a short time there could easily be a "scary" 10% drop in the middle of that sort of run.

Big fast rallies have happened many times in history. The magnitude of my base case would be far from record setting and if this one turns out to be wrong then rallies like this (20-25% in six months or so) will happen in the future. Big rallies can happen when the fundies are good and when they stink--I happen to think they are not so hot right now.

As excited as the media seems to be about this current lift in the market a swift 10% decline in the middle of this will scare a lot of people, bring out the bearish extrapolators and generally cause an overreaction. You could of course accuse me of overreacting but I did write about this two months ago and began to reorient our positioning before that.

The ways in which my range busting scenario could be wrong are almost limitless. The SPX could stop right here and then go down a lot, it could stop right here and just hover for an extended period, it could go up a lot and then keep going or go up and hover there and so on.

As I mentioned recently, if you actively manage a portfolio you probably have some thoughts about where we are and where we are going. You will be right occasionally and wrong occasionally, when you are right you need to go with it and when you are wrong you need to be able to recognize when you are wrong and figure out how to adapt.