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The Trader's Dilemma: Skeptical, but Still Long

The trader dilemma: Many stock traders are bearish in their outlook, but they are set up long! How can that be? Many traders feel that the market leaders--particularly financials--are way overbought and poised for a pullback--but they have been poised for a pullback for a month--and the market has gone the other way!

This has kept traders in the market, but only made some even more skeptical, and cynical.

Bulls note that short interest is down, and that the GS Hedge Fund survey indicated many traders were positioned bullishly in terms of what they owned (not what they thought!)

With earnings over, traders are turning to sector analysis. It's no secret that the rally from both the March lows and the summer rally that began in the second week of July has been led by financials and, to a lesser extent, technology.

In addition, commodity stocks and consumer discretionary (retail & homebuilders) have outperformed technology in the summer rally.

Laggards have included energy, consumer staples, healthcare, and telecom.

So what to do? Most professional traders have little confidence in the dramatic rise in prices of Financials and feel that money should rotate out of that group.

But into what? There is a large crowd that continues to move money out of the U.S. and into international names--emerging market ETFs like the iShares Emerging Market Index and Vanguard Emerging Markets have seen strong volume in the summer rally.

Energy stocks have shown very little benefit from the rise in oil; some have no doubt lagged because many energy stocks have natural gas exposure.

The two most likely (U.S.-based) candidates are defensive: healthcare and consumer staples. While this may not sound exciting, if the market rises even modestly it will continue to attract long-only money that needs broad exposure.

Money has begun to rotate into Healthcare in the last couple weeks as it seems clear the more extreme elements of healthcare reform will not materialize.

Outside stocks, I'm surprised by how many stock traders profess to be bullish on the dollar, under the theory that 1) no one else is bullish, and 2) the U.S. will start unwinding quantitative easing before anyone else.
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