From my morning research note this morning:

At the end of last week, the Russell 2000 and Nasdaq Cash indexes stood at levels not seen since late 2007.  Large caps have lagged slightly on the recent rally, but the S&P 500 appears to be firmly above the 1220 level on the Cash which we identified as a major inflection point over a year ago.  In addition, domestic indexes now stand at the top of our developed market relative strength rankings, and we believe the market is set up very well for a rally into the end of the year.

In terms of sector themes, we have been most impressed by recent strength in Financials….  In addition, we are seeing a resumption of leadership in Energy, Basic Materials and Industrials.  Currently lagging sectors are the traditionally defensive Utilities, Consumer Staples and, to a lesser extent Healthcare, and we are seeing continued strength in the Consumer Discretionary / Staples index which we use a one proxy for investor sentiment.  At this point, all probabilities seem to favor a continued rally, but we continue to look every day for signs that this conviction may be wrong.  Weakness in US Equities should be seen as an opportunity [for swing or position traders] to add to longs until further notice.

Chinese and Brazilian equities have declined to support levels, but we do not favor establishing heavy exposure at this point.  We are concerned about large-scale technical weakness in these markets.  Probabilities do favor a rally from current levels, especially if our domestic equity call is correct, but we are becoming concerned about the “tail risk” of a very large decline in China and Brazil if world equities should turn down.  We believe that many market participants may be underestimating the potential risk in these two regions….

Currencies: From an anecdotal perspective, we see some possibilities that the rise in the USD (and corresponding decline in the EUR) has run its course, and we would suggest that longs aggressively manage their exposure on any decline. We are carefully monitoring a number of currencies on an intraday basis, and may enter a USD short position on weakness. If so, this trade will be entered with a reasonably wide stop point (around 83.00) and a correspondingly small position size. We have no crystal clear pattern at this time, but a number of technical elements seem to suggest the possibility of a renewed downtrend in the USD.

The S&P 500 is set to open at significant multi year highs.  Keep it simple this morning–I will be using 1237 on the March futures as an inflection point.  As long as we are holding above that level, I will be in bullish mode, realizing that, even though the market is overbought on higher timeframes, there is a good chance of a pretty dramatic rally today above that level.  Dropping back below that 1237 (which is a significant overnight level) takes a lot of the edge off the argument for a rally today, and I would expect to remain more rangebound below that level.  The chance of a significant selloff does seem small today, especially with no significant economic catalysts due out today, but the rubber band is stretched pretty far to the upside.  If the market is weak and we see good intraday momentum to the downside, I will not hesitate to play the downtrend, but also will not be very likely to take short exposure home overnight.

I realize I just outlined scenarios for up, down and sideways, which may not seem very useful.  I would put the chance of a selloff at very small odds today (<10%), while the extended rally scenario is very likely (>70%).

We see no clear setup in precious metals today, though roll-adjusted Copper futures traded to new 52 week highs overnight (certainly not weak.)  In the absence of a real driver in the metals, I will tend to focus less on Basic Materials in general today.  The bulk of my early focus will be on Financials, as I think this deeply oversold sector could well extend on a broad market rally.  Lastly, the USD does seem poised to be weak today, and daily charts show what could be a significant turn.  If I am correct on my call for the Dollar (which is a 50/50 proposition at this point, though I believe risk:reward greatly favors the bears from current levels), this will be a tailwind for appreciating equities, metals and other physical commodities into the end of the year.

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Note this was published at 8 AM.  I will revise before 9:30 if anything should change significantly.