MAKE OR BREAK

The markets have trended up with low volatility since mid-December.  With little to no correction or pause, the markets are getting a bit extended at these levels.  A healthy market would do a little backing and filling at these levels to digest the gains and prepare for the next surge upward.   In contrast, a continuation of this pattern would be deemed unhealthy and would set the stage for an unpleasant and potentially steep sell-off down the road.  In principle, the farther an instrument advances without a pause or rest, the more pronounced the inevitable pause/rest/selloff will be.

With the recent lack of volatility, is the market trying to tell us something or just ignoring reality?  Some would argue the latter but the market is usually right and the decreased volatility is more likely the market's response to what it deems likely outcomes in the US and abroad.  The low volatility uptrend will not continue indefinitely and is getting a little long in the tooth.  The next correction, whenever it comes, will tell us much about where this market is headed over the foreseeable future.  The major indices are at or nearing their 2011 highs and thus approaching significant resistance.  Pushing through these levels would be a huge jolt in the arm for markets that seem to want to go up.  There is still much that could derail the weak economic recovery.  The most obvious source of potential problems is Europe.  It is hard to envision a scenario in which Europe overcomes their current sovereign debt problems without major economic upheaval, but if they were able to figure out how to accomplish just that, this huge negative for the global economy would become a powerful positive force.

The Federal Open Market Committee (FOMC) meets today and tomorrow so market action may be muted until the meeting is concluded.  There will not be any change to the two key interest rates that the Fed controls directly but there could be changes in the statement language that hints of future Fed policy.  Several voting members have changed since the last meeting and the new makeup of the FOMC is considered to be more dovish on inflation and therefore more apt to consider another round of quantitative easing (QE3).  Any hint of QE3 would likely be positive for stocks in the short-term.  If QE3 is a valid Fed alternative, they are likely to act soon so as to avoid any perception that they are trying to influence the election process.  Additionally, if there is another round of easing it will almost certainly be aimed at the mortgage market to attempt to restart a lagging housing market.  This will be an area to watch closely as things develop over the coming weeks.  Lots to look at and digest.  It is always interesting...

Sam and Bo