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October 20, 2011

The Takeaway: Risky assets dance around the unchanged line as investors have a hard time deciding what to believe -- better economic fundamentals or nagging fears that the euro is going to fail.
 
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Stocks recovered from early losses to finish in positive territory Thursday as the market's rollercoaster ride near resistance from the three-month consolidation range continues. Again, the eurozone's woes dominated the attention of traders after last night's emergency meeting between the heavy hitters -- including German, French, IMF, and EU officials -- broke up with no resolution.
 
Now, with the October 23 eurozone summit approaching and French/German officials at odds over plans to turn Europe's bailout fund into a bank with European Central Bank backing, a second meeting is scheduled for as early as next Wednesday. A solution needs to be found by the G20 meeting on November 3.
 
The good news was that Muammar Gaddafi met his end in a Libyan ditch as rebels snuffed out, literally, the last remnants of his tyrannical rule. Other good news included the leaking of the "troika" report on Greece, with officials from the IMF, the ECB, and the EU all recommending that Greece should receive its next €8 billion bailout installment "as soon as possible." The Greek parliament also passed a tough new budget austerity bill -- all but securing its next batch of bailout cash.
 
In the end, the Dow Jones Industrial Average gained 0.3%, the S&P 500 gained 0.5%, the Nasdaq lost 0.2%, and the Russell 2000 gained 0.3%. The Edge Letter Portfolio gained 0.6%.
 
 
Financial stocks led the way with a 1.8% gain thanks to a better-than-expected earnings report from regional lender Fifth Third (FITB), which pushed shares up a whopping 9.1%. Our financial positions moved higher in unison, with ING Group (ING) adding 3% to bring its total gain since we added it on September 19 to 27%. 
 
 
If investors have seemed more indecisive than normal lately, well that's because they have been: The Dow has alternative directions for 11 consecutive days. That's something that's only happened five other times in the index's history. The last occurrence was in May 2009 -- which like now was a period of sideways churn after a massive, historic upward surge.
 
 
That's no surprise. The initial part of the uptrend was fueled by bargain hunters, short covering, and a turn in the economic fundamentals. We've had all that. The next phase requires that the pessimists be dragged, kicking and screaming, into a net long positioning as they can no longer deny renewed economic strength.
 
That's starting to happen now. And that should fuel a powerful breakout from current levels -- assuming, of course, that European leaders continue to work towards and eventually find a solution to their woes.
 
(We've covered the eurozone crisis at great length lately, so you should already be familiar with the steps required: Stress test euro banks assuming sovereign debt is marked-to-market, recapitalize banks that need help, conduct orderly default of Greece, and turn the bailout fund into an insurance vehicle to attract new private investment in the eurozone.)
 
 
The chart above of the Citigroup Economic Surprise Index illustrates this dynamic. It shows how for the first time since late April, economic reality is consistently beating Wall Street's expectations, pushing the index back into positive territory.
 
These pleasant surprises are like dry kindling beneath the stock market -- all we need is a flash of confidence to set it all ablaze. Maybe it's more progress in Europe. Maybe it's more strong Q3 earnings results. Maybe it's a positive development out of Washington -- including passage of portions of President Obama's jobs bill, such as the payroll tax cut component.
 
Or maybe it's just the reporting of more and more good economic data, pushing double-dip recession fears further from the minds of investors.
 
 
We've gotten more of that this week. Housing starts jumped in September to the highest rate seen since early 2010 and before that, late 2008. The Philadelphia Federal Reserve survey of mid-Atlantic business conditions jumped back into positive territory and posted its best month since April. And the Index of Leading Economic Indicators posted its fifth consecutive monthly gain thanks to positive readings on metrics like vendor performance, consumer expectations, and new orders for consumer goods.
 
 
In fact, the economy has been tracking so well over the last few months -- despite all the turmoil in the financial markets -- that the normally dour bunch at Capital Economics in London are looking for Q3 GDP growth to come in 3.2%. That would surprise a lot of people who are still obsessed with the worst-case double-dip, financial crisis, euro breakup scenario.
 
God knows there is still plenty of room for opinions to change.
 
We've looked at things like newsletter writer opinions and net short positioning over the last two weeks. Today Charles Rotblut, vice-president of the American Association for Individual Investors and editor of the AAII Journal, notes that individuals' bearish opinion has been above average for 32 of the past 35 weeks. That's rare. So rare that has only been seen twice since the survey's inception in 1987.
 
The first was in 1990 and came ahead of what was arguably history's greatest bull market. The other came in 2007 ahead of a long, two-year bear market.
 
Right now, with corporate profits surging, interest rates near-zero, and the world's central banks pushing more stimulus into the financial system, I think we're much closer to seeing a repeat of the 1990 scenario than the 2007 one. At least, that's what the hard evidence suggests.
 
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Trend
 
 
Last Signal:
Buy (October 11, +58.4%)

 
Previous Signals:
Buy (October 10, +54.8%)
Buy (October 7, +70.6%)
Buy (October 6, +97.7%)
Sell (September 22, -127.6%)
Buy (August 29, +90.5%)
Buy (August 26, +44.8%)
Sell (July 27, -80.5%)
 
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The TREND indicator is based on a collection of momentum and breadth indicators that assigns a numerical score to signify the direction and strength of an uptrend or downtrend. Trend Direction is responsible for buy and sell signals while Trend Strength signifies uptrends and downtrends. 
 
Movements in Trend Direction measure above and below zero are the main buy or sell triggers if accompanied by sufficient price velocity: A move from negative into positive territory is a buy signal while a cross from positive into negative territory is a sell. The move is later confirmed by the Trend Strength measure.
 
Interpretation of meaningful movements in the Trend Indicator will be featured as they happen.
 
 
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Portfolio
 
 
Let's take profits in our semiconductor holdings as the sector looks ready to cool as other areas -- such as financials and industrials -- begin to attract some attention. In particular, insurance stocks are coming to life as high yield bonds, which they hold a lot of, push higher.
 
Core
 
Sell both Direxion Daily 3x Semiconductor Bull (SOXL) positions
 
Buy KBW Insurance Index ETF (KIW) -- 25% Position
 
 
Explore
 
Sell Micron Technology (MU)
 
Buy Old Republic Intl. (ORI) -- 12.5% Position
 
 
Thanks for reading and have a great day,
Anthony
 
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Programming note:

Given the surge in new subscribers, our current email servers have reached capacity. As a result, new subscribers may not be receiving email alerts when new issues of the Edge are published. We are working on moving our system to Amazon Cloud Services, but this will take a couple of weeks.

In the meantime, I recommended that new subscribers track our Twitter account (@EdgeLetter) to get alerts when new mid-day updates and portfolio recommendations are made. Mid-day update alerts will also be sent via Twitter. Evening editions are published around 5pm PT/ 8pm ET or before.

I apologize for any inconvenience. This note will continue to run at the bottom of the evening edition until the email issue is resolved.
 
 
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