Another week has gone by and stocks continue to defy gravity. Recently the market has suffered from selective hearing. It only heard good news and ignored any bad news. This sort of environment doesn't last forever and the market is going to need to see some real evidence that the economy is recovering as we head deeper into the fall. After the second quarter earnings season analyst and investor expectations have risen sharply and forecasts are being revised higher.
We could argue that the July rally was fueled by short covering. It was also fueled by hope and fear. Hope that the economy is truly improving and we'll soon see growth. Fear from money managers that if they don't get in now they'll miss the rally. I've said it before. Professional money managers are scared. They're scared to under perform their benchmarks (normally the S&P 500) and they're scared to under perform their peers. Their bonus and for some their jobs depend on performing well. This has left them chasing the market higher.
We are not professional mutual fund or hedgefund managers. We are individual traders and don't face the same performance anxiety or pressures. Therefore we can choose how and when we deploy our capital. We don't have to chase this rally. We're allowed to wait for a better entry point. The question is, "what do you fear?" Do you fear losing money or do you fear missing out? Are you going to be more upset if you went long the market (stocks, or LEAPS) now and lost money on a correction? Or would you be more upset if the market broke out higher from here and ran another 10 or 15% without you?
Can the market run higher from here? Absolutely. It can also correct sharply. The market is always right. We just have to try and discern what it's trying to tell us. I believe the market is telling us that for the next four or five months the trend is up. Hopefully we'll see a couple of pull backs along the way and if we're ready for them we can use them as entry points. The current environment with money managers chasing performance is unlikely to change for the rest of 2009. That means that any correction is likely to be shallow and smaller than we might expect. Right now I'd love to see the S&P 500 dip back toward the 950 level. As broken resistance it should be support and would seem to make a great entry point to get long the market again. We will see 950 again? I don't know but given the condition above (shallow corrections), maybe not. That means we may want to jump in around 970 or 960.
Technically the market has stalled at serious resistance. The 1,000 area is not only psychological resistance for the S&P 500 but it's also the 38.2% Fibonacci retracement from its 2007 highs. The 1,013 mark is a 50% bounce off its 2009 lows. The 1,016 level happens to be where you'll find the 200-month moving average for the S&P 500. These all add up to heavy resistance for the index, which explains why the rally has stalled. A breakout from here would be pretty bullish and probably spark another massive wave of short covering for those still short (short interest has been falling). If this occurs I'd target a rally to 1,060 and 1,100. Would I launch new long-term LEAPS positions on a move over 1,020? Probably not but nimble traders could certainly try more short-term strategies.
Weekly chart of the S&P 500:
Monthly chart of the S&P 500:
The big picture has not changed. Last week it was announced that foreclosure filings, potential foreclosures, rose to more than 360,000 in July. That's a new all-time high and accounts for 1 out of every 355 households in America. I believe that's the fifth month in a row that foreclosure filings have been over 300,000. I've been warning readers for months that there is another tidal wave of foreclosures coming. The recent bounce in sales and the very minor improvements in home values could easily be swamped by this wave.
I am still in the "W"-shaped post-recession bounce/recovery camp. I expect the economy to grow in the third and fourth quarters. The first half of 2010 could be dicey. This "W" bottom outlook may end up being a tough position to hold on to. As we see more and more improvements in the second half of 2009, thanks to the inventory-rebuilding phase, there is going to be a huge amount of hype and media attention about how wonderful the economy is and how we have nothing to fear. Don't be surprised by it but more importantly don't be seduced by it. We're expecting stocks to trend higher for the rest of 2009 anyway (hopefully with a couple of pull backs along the way). I just want to urge caution when you start looking out to 2010.
Consumer spending is still weak and likely to remain soft for the foreseeable future. That means back to school and the 2009 holiday shopping season are probably going to be worse than expected. If the consumer doesn't participate in the recovery then it's going to be a very unstable rebound. We're also seeing signs of deflation here in the U.S., Europe, China and it's already evident in Japan. If we combine deflation with falling housing prices, weak consumer demand, tight credit markets for business and individuals, and a fragile commercial real estate market, then the bulls have one heck of a wall of worry to climb.
~ James Brown