WHAT MOVES MARKETS?

The most common answer would be supply and demand. What drives supply and demand? Fear and Greed. What causes fear and greed? Market sentiment. So it can be said that markets are not moved, not at least in a macro way, by earnings, P/E ratios, news, etc; markets are moved by mass sentiment. I consider there to be 3 ways to analyze markets: Fundamental Analysis which I believe is inherently flawed and grossly misleading. Technical Analysis which has its flaws, but if you understand the limitations and think outside of the box, TA can be useful. And last, mass psychology. In a way, technical analysis is about mass psychology. So with the markets being so thin right now, volume so low, price discovery non-existent, I look to sentiment to understand what I see on the macro charts and for those of you who are new, what 3C has shown is distribution into higher prices, sentiment can be said to be negative in that respect. This seems to be at odds with prices at or near recovery highs, but distribution occurs into higher prices-it's a counter-intuitive reality.

For over 6 months we have seen massive and consecutive outflows of money from domestic funds, causing many to go belly up this year. Investors have fled the market, yet we have some of the most bullish sentiment seen in quite a long time.

Today the NYSE released data showing that investors are going long the market on increasing levels of margin, this shows investors have little fear as they buy stocks on borrowed money. This is a continuation from the previous month of October which also saw a rise in margin debt.

Compare low margin debt and high margin debt with the S&P, what you'll find s low margin debt at the start of major rallies and high margin debt at the start of major market tops.

Tuesday it was revealed that NYSE short Interest hit lows for all of 2010

As I showed last night, the Baltic Dry Index is slipping to new lows, meaning there's little demand for shipping, this is not economically bullish.

Tuesday we saw Consumer Confidence come in at a huge miss, consumers are worried, but the market? No negative reaction, this is an example of bullish sentiment.

Also on Tuesday, the Case Shiller Home Index missed big showing 4 months of housing declines and what is now a double dip recession in housing underway. The market's reaction to the news (and it's never the news that is important, it's the market's reaction to the news)-muted, really just whistling past the graveyard-no cause for concern. It wasn't even enough to move SRS, the Short Real Estate ETF. Again, bullish sentiment as the market ignores the news.

Housing is down more then 30%, yet property taxes are on the rise.

On Monday, the Dallas Fed's Texas Manufacturing Index is another big downside miss with expectations of a print of 17 with the index coming in at 12.8. Behind the headlines, rising material cost, rising labor cost and falling orders/demand. Did the market sell-off? No. Once again, an invincible euphoria fills the market.

Along those lines, commodity inflation is here.

Over the Christmas Holiday, China, hikes interest rates for the second time in less then 3 months as they try to reign in the global growth engine, does the market care? Nope.

The Fraud perpetrated in foreclosure, which is gaining in intensity should be sending banks to the abyss, yet this week we see a rally in financials.

No one wants to touch US Treasuries so the Primary dealers buy them and then sell them back to the Fed, effectively monetizing our debt, but the key here is there is no confidence from outside or inside the US to own American debt. Cause for concern? Not as long as the Fed keeps monetizing the debt.

The ECB in their own white-wash version of buying up debt and then trying to get it off their balance sheets, sees a lack of demand to complete the white wash job-no one wants to hold European debt and Shanghi has it's own failed auction of short term debt and last week, despite Chinese support, the Spanish have an ugly debt auction. Is the market concerned? Not a bit.

Last week New Home Sales misses expectations and the previous month is revised lower. There's now over 8 months of supply on the market to be worked through, the market remains indifferent.

Existing Home Sales comes in at a miss, expectations of 4.75 million, comes in at 4.68 million with 9 and a half months of overhang/supply.

Michigan Consumer Confidence seems to come in okay, unless you read beyond the headline, the report shows inflation expectations rising. We already know that food and gas prices are rising, in other words those things that we use everyday.

Also released last week, the AAII sentiment survey shows the highest bullish sentiment since November of 2004; jumping from 50% to 63%, bearish sentiment drops from 27 to 16%, the lowest level since November 2005. The difference between the two is the highest since April of 2004.

December 22, the Fed admits housing prices are slipping, there is no stabilization in home prices, there is a huge amount of “over-supply”, over 6 MILLION properties are behind 60 days or more, in foreclosure, have been foreclosed or are already in bank supply and the kicker-”With nearly half of total bank assets backed by residential real estate, both homeowners on the cusp of negative equity and the banking system as a whole remain concerned amid the resumption of home price declines”.

On the 22 of December, Q3 GDP final revision comes in lower at 2.6 on expectations of 2.8%. Inventories are up, consumption is down.

Also last week on the 22^nd, The Mortgage Bankers Association Index -mortgage applications are down nearly 19% from the prior week and refinancing down nearly 25% from the prior week, with one of our own members in the industry saying that on the ground where he works, those numbers seem light-in other words, from his first hand experience at his bank, things were worse then what was being reported.

For months now and I'm not sure how many but many, consecutive months we have seen a huge disparity, consecutively between insider buying and insider selling, with the ratio even reaching the 5 digits to 1 at one point. Insider selling has been unrelenting. Maybe they know something we don't, but does the market care? You know the answer.

We have been seeing outflows of high grade bonds and now we are seeing a mass exodus from municipal bonds. Default seems inevitable without some very big and very direct intervention as the supply on the market from bond holders is huge, new issuances will require rates so high, there would have to be an eventual default.

2010 has been the worst year for bank failures since 1992.

As for stock participation in the push higher in the averages, I posted a breadth report a few weeks back, it's not just bad, but getting worse, I'll post another soon.

And today, we see for the first time in an inflow into domestic funds after 33 consecutive weeks of outflows. Retail investors have returned.

And why not? The perceived risk in the market is very low, look at the VIX.

This is complacency and it's been in place for sometime. Now with retail entering back into the frey, I can think of one word, I can't help but think of this word-”Contrarian”. The sheep have returned to graze. Sentiment is clearly at an extreme. Could this time rally be different?

Ashton Crutcher doesn't think so, he' preparing for the end of times.

For now, keep those alerts set and take what the market gives us, but be on your toes and don't fall in love with an idea that seems ingrained permanently into the investing fabric of US equity markets. Change sometimes occurs suddenly and often when that happens, violently.