The sequester is real, but not catastrophic

Here's what I think...

This past weekend I laid out the case for a pause in the rally that began the week of Thanksgiving.

Beneath the surface of the stock indices themselves, a narrowing of leadership began to asset itself beginning in late January. Momentum was slowing and defensive sectors began coming to the fore throughout February. All of sudden, tech dropped off the new highs radar and materials started to act like, well, like materials again.  This coincided with negative divergences in both core and peripheral Europe. We got some nasty data out of Europe on the economic front and then all hell broke loose in the Italian election headlines.

Today, we're seeing a boost in the risk-on cohort, small caps, cyclicals and high beta are doing their level best to finish the month out with pizazz - all of this is textbook from a tape reading standpoint.

But! 

I maintain the following:

Breaking all-time highs for the Dow and S&P should not be a walk in the park, especially with five years between peaks. We shouldn't be able to just rip through to the upside - we should be forced to earn it. This means bumping up against overhead resistance, a few false moves and maybe even a headfake 7-10% correction before we've built up a big enough head of steam to convincingly break through. Happens all the time in individual stocks and what are markets if not a collection of them?

The broadening top in the Dow that everyone sees may be just that - sometimes the crowd gets it right after all.

Narrowing leadership is still an issue. I watch the NYSE summation index to gauge this and I'm not loving what I see at this moment.

Sequestration's impact on the economy will be real - not catastrophic but absolutely real. I believe that public companies will use this event as an excuse to lower expectations for Q2, Q3. They'd be stupid not to.

The headlines emanating from the rolling fiscal cliffs from March through May will foster an atmosphere of increased correlation and market whippiness - a minor league version of 2011's risk-on, risk-off atmosphere.  This will lead to many short-term traders getting chopped up and all kinds of opportunities for fear-mongering in the press. prudent investors will ignore it all and stay the course.

Markets peaked out early in 2011 and 2012, it will be no surprise if we follow this seasonal pattern.

The worst thing in the world would be a quick drive higher here with utilities and consumer staples leading. It would make the correction worse because more dollars will get sucked in.

At a certain point this summer or fall, it will become apparent that the Sequester - while short-term painful - wasn't the worst thing in the world and that the economy, the consumer and corporate profits were able to weather it and make it through to the other side. Along with having the Fed on hold, this could set up the next leg higher with housing leading the recovery followed by increased hiring.

But the headline hurdles in front of us still must be surmounted, there is more work to do as estimates and expectations fall in line with reality, in my opinion.

And so we chill out and watch with mock amusement as a few million people get either too bullish or too bearish at exactly the wrong moments over the next few months. We keep our favorite holdings on the equity side of our portfolios, ignore the noise and await a better time to add more exposure.

This is an incomplete roadmap based on data, intuition, street smarts and experience. Things can and will change, of course, but right about now this posture seems to be the correct one.