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Stock Rally Drags On, but Divergences Are Emerging

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The rally drags on, and on, and on ... no home runs, but every day we grind out a single (35 points, 38 points, 125 points, 42 points, 33 points, 67 points, 50 points, 2 points, 5 points) that's how much the Dow Jones Industrial Average has been up each day in March. You string this all together, you have a 3 percent rally in nine days. Pair it with the rally in January and February, and suddenly the Dow industrial average is up 10.3 percent this year.

What's going on? On almost every one of those days, there was some economic data point that was better than expected.

(Read More: Dow's Best 1st Quarter Since 1998?)

Of course, almost no hedge fund is up 10.3 percent this year. No one was set up for this slow-grind rally ... and of course, the higher it goes, the more traders it drags in.

Pullbacks? Oh, we've had that ... 3 percent at the end of February. We will, of course, get another pullback ... but only when everyone throws in the towel.

Divergences: Global correlations are breaking down a bit — instead of risk on, risk off, it's more selective.

The main trend, which I highlighted yesterday, is that emerging markets are underperforming, U.S. is outperforming. The stronger U.S. economy, and concerns over China, are the driving forces.

There's one other 800-pound gorilla in the room: the rising dollar. With the dollar rallying 4.5 percent in the last six weeks, everyone investing in foreign country exchange-traded funds using dollars is seeing their investments deteriorate. So, for example, the Nikkei is up 19 percent this year, but the iShares MSCI Japan ETF is up only 7.5 percent. Huh? That's the dollar rally!

There are workarounds. Wisdom Tree has had a huge hit with its Japan Hedged Equity ETF, which hedges out the currency exposure ... it's also up 19 percent, mirroring the Nikkei rise. More on this later.

The good news: A strong dollar is not hurting the S&P 500. The improving U.S. economy has changed that dynamic.

Elsewhere:

1) Whatever happened to quadruple witching expiration? It used to be a big event, with big volume and volatility, but it's not any more.

Tomorrow is a quadruple witching day, the quarterly expiration of stock index futures and options, and individual stock futures and options. This week, we have kept advancing, but volume has been moderate at best. Volume is usually higher on a quadruple witching week.

This has been going on for some time: December expiration was a non-event, as well. The roll (rolling over options positions) is not what it used to be: There does not seem to be as much hedging as there has been in the past.

Why not? One explanation is that traders are just not as heavily invested as they used to be.

But there are other explanations:

a) Low volatility and low volume: A low volatility environment creates less incentive to buy protection.

b) An increase in alternative assets: increasing trading in VIX products as a hedge has reduced some of the need for options hedging, and just think about what you can do using ETFs to hedge. You can buy transports using an ETF and sell, say, financials. All that reduces the need to buy and sell options.

c) There are many more options: More monthly options, more weekly options than ever before. The ability to time your hedge has greatly increased. Most importantly, there are quarterly options that expire at the end of the month that some may also be involved in.

Bottom line: The trading environment is changing, and you can see that in the options world.

2) E*Trade Financial tumbles 5.2 percent pre-market after news hedge fund Citadel will issue a secondary offering to sell its remaining 9.6 percent stake, or 27.4 million shares, in the brokerage company. Citadel, which bailed out E*Trade during the financial crisis, had owned as much as 40 percent of its common stock in 2009. The hedge fund benefited from a deal with E*Trade to route 40 percent of its customer trades to Citadel's brokerage unit, but that arrangement ended in 2010. Declining trading volumes have weighed on E*Trade, falling 10 percent in February from a year earlier.

3) J.C. Penney gains 3.1 percent pre-market after BTIG initiated the stock with a "buy" rating. BTIG said entering the retailer is "an option on the ultimate outcome of the firm's transformation, and that this option is accompanied by a number of levers which favor the equity investor." The firm set a $22 price target on the stock.

A number of other firms have also recently commented on Penney. Analysts at Deutsche Bank reiterated a "hold" rating in a research note to investors on Monday. Separately, analysts at Northcoast Research to a upgraded the shares to a "neutral" rating from a "sell" rating in a research note to investors on Thursday, March 7, with a $14 price on the stock.

By CNBC's Bob Pisani

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  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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