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Kass: Trade the Range

This blog post originally appeared on RealMoney Silver on March 29 at 9:02 a.m. EDT.

In his seminal book Margin of Safety, hedge fund manager Seth Klarman tells an old story about the market craze in sardine trading. One day, the sardines disappear from their traditional habitat off the Monterey, Calif., shores, the commodity traders bid the price of sardines up, and prices soar. Then, along comes a buyer who decides that he wants to treat himself to an expensive meal and actually opens up a can and starts eating. He immediately gets ill and tells the seller that the sardines were no good. The seller quickly responds, "You don't understand. These are not eating sardines; they are trading sardines!"

Similar to Klarman's tale, today's market is a trading-sardine market, not an eating-sardine market.

As previously noted, there appears to be no real trend nor is there likely to be one over the short term. Instead, a range-bound market confined between 1,250 and 1,350 on the S&P 500 seems to be a reasonable expectation.

In all likelihood, we probably hit a low for the next few months at around 1,250 on the S&P on Japan's "Nuclear Wednesday" a few weeks ago. In that case, profit-taking was absorbed without a severe setback, a classical sign of a good bottom.

But there are numerous fundamental and technical factors that support the notion that the upside might be limited, too.

For now, buying the dips and selling the rips, which is good for opportunistic traders but bad for the buy-and-hold crowd, seems a reasonable tactical response to these conditions.

The core challenge to the markets? Upside surprises, both profit and economic, have likely peaked, and downward revisions will probably occur with more frequency.

There is more economic and profit ambiguity emerging, and the consensus profit forecasts for the S&P have become the best case and are no longer considered the likely case.

The good thing is that bullishness has ebbed, and there is some fear. Animal spirits have subsided, and valuations are not unreasonable.

I continue to believe that comparisons to the market correction in November 2010, which morphed into another bull-market leg, are not yet in place. What would make me more positive technically would be a shift out of the defensive area (a deterioration in consumer staples) and/or a breadth thrust accompanied by a 90% up day. These are the conditions that reversed the November 2010 correction.
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