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January 3, 2013  Thu 8:29 AM CT

EEM: SEE CHART GET CHAIN FIND STRATEGIES

It's hard to be bearish after Congress avoided the "fiscal cliff." Plenty of noise and posturing will remain--the debt ceiling in March and higher taxes in the near term--but in my view these are not important enough to derail the rally now taking shape.

While all the attention focused on Washington in recent weeks, positive trends have been taking hold in the market that now have the potential to become the dominant themes:

  • Risk appetite has been mounting: The S&P 500 is down more than 1 percent in the last three months. But during that same period the Dow Transports Index rose 8 percent, emerging markets (EEM) rose 6 percent, and the Russell 2000 small-cap index advanced 1 percent. If people really had been worried about recession, this would not have been the case. Technicians and followers of Dow Theory would also consider the strength in transports as a "non-confirmation" of the recent drop in the broader market.
  • The S&P 500 never broke support: The index pulled back within a channel since peaking in September. The late-2012 selling brought it only to the lower range of that channel. It held 1400 and is now back above the 1420-1430 area where it stalled in late October and early November. The SPX is also bouncing once again above its 200-day moving average and has made yet another higher low coming off the nadir of March 2009.
  • China is back: The world's No. 2 economy is back in growth mode. The current expansion has also taken shape at the same time that the rest of the globe was turning nervous about fiscal problems in Europe and the United States. Other data has also shown that domestic demand continues to take shape on the mainland--an extremely positive development. The iShares Xinhua China Index Fund (FXI) has already moved on this trend, gaining 20 percent in the last three months while the S&P 500 has been flat in the same period. I am definitely not recommending chasing the FXI here, but strength in China will lift many boats for months to come, especially energy, coal, steel, and copper. Chinese Internet stocks like Baidu (BIDU) and Sina (SINA) are also worth a look on the next pullback.
  • Materials have bottomed: Every name in this group seems to have found solid support at long-term lows: U.S. Steel (X), Alcoa (AA), Freeport-McMoRan (FCX), BHP Billiton (BHP), and Rio Tinto (RIO).
  • The Japanese yen is getting destroyed: This currency was artificially strong after the Tsunami in 2011 and amid worries about weakness in Europe. But it's been falling hard since September. At some point that's going to bring back the big, indexed "carry trades," with hedge funds betting billions of dollars selling the yen and buying commodities and emerging-market currencies. Tokyo's commitment to a weaker yen will drive that trend.
  • Volatility seems non-existent: I have my own theory on this one, which is that low interest rates globally are depressing volatility. Whatever the reason, every attempt by the VIX to rally has been very short-lived. It looks as if we're settling into a period similar to one we saw between 2003 and late 2006, with steady declines in the VIX against the backdrop of a growing economy.

Given yesterday's big rally, expecting more gains of this magnitude in the short term is probably unrealistic. In fact, we might see a test back toward the 1440-1445 area. If this does happen, that's the time to get long. The new bull market has begun, folks!

spx

(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Jan. 2. Chart courtesy of tradeMONSTER.)

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