Why the Stock Rally May Fizzle Out

It has finally happened. After four failed attempts in the previous week, the DOW closed above 12,000 on Tuesday for the first time since June 2008. And, surprisingly, blue-chip stocks are leading the charge this year with a four-percent gain, as there appears to be a slight rotation from growth stocks into blue-chip and large-cap stocks.

However, the rally being made by stocks may fizzle out.

In the broader market, the S&P 500 closed above 1,300 for the first time since 2008, and it is up 3.98% this year. But, as far as February goes, the S&P 500 has been largely weak, with four up months and eight down months over last 12 years, with an average loss of 2.4%, according to Stock Trader’s Almanac.

Stock markets are also technically overbought and the Relative Strength (RS) is neutral, so watch this, as there is a negative divergence between the rally and the RS.

I sense that a correction is due given the uncertainties. You should be aware of this.

Watch to see if the indices can hold, but it would not be critical, as I believe volatility will dictate trading this year.

While the technical breaks are encouraging and markets could continue to edge higher, traders appear to be ignoring the global risk and are focusing solely on the domestic climate.

However, there are the current tensions and uncertainties in the Egypt and the Middle East. There will be a change in leadership in Egypt and this will create political uncertainty.

In Europe, the debt and deficit situation continues to be a real threat that cannot be overlooked. Keep a close eye on Spain. Failure here could be devastating.

Then there is China.

Chinese inflation is a real potential threat on growth and stability not only in China, but also globally with its trading partners. Inflation is estimated by economists to rise to an annualized 5.3% in January. We are seeing higher-cost Chinese-made goods.

With the beginning of the key Lunar New Year holiday in China, the country’s premier Wen Jiabao said that the government would deal with the inflation and surging real estate prices.

According to economists with knowledge of the thinking of the Chinese government, there is a belief that the Chinese government will raise interest rates within a month, followed by two additional increases by mid-year. This is a concern for Chinese stocks, but would also negatively impact the other global markets.

My advice is to ride the rally, but, at the same time, don’t ignore the global risk. Stocks are currently sizzling, but could soon fizzle out with a correction.