You might be familiar with the term "the Ides of March" from Shakespeare's play "Julius Caesar". Given Caesar's assassination on that date the term has taken on a more foreboding tone. Not many people know that the Roman calendar also used the term "Ides" for the 15th day of May, July, and October. Now I'm not going to warn you to beware the Ides of October but the S&P 500 rallied to 1,096 on Thursday the 15th and it could be a short-term top for the market.
The market's trend is obviously upward but there are several warning signs to consider. The easiest to see is that stocks are short-term overbought and running out of momentum under key, psychological resistance. The S&P 500 has the 1100 level looming above and the DJIA is struggling to hold the 10,000 level. A minor pull back would be in order and I would look for support near the S&P 500's rising 40 or 50-dma around the 1050 level. This happens to coincide with minor support at the 1060 and 1040 levels. Another technical warning sign are the bearish divergences we're seeing between price (new highs) and some of the indicators, which are not hitting new highs.
A bigger warning sign could be the reaction we are seeing to earnings results. If I were an ancient Roman-era soothsayer I might warn investors to beware the Ides of Earnings Season. The quality of earnings is front-loaded and will steadily get worse as the season progresses. Thus last week and this week should bear the best results and if last week is any indication we could be in for a rocky ride. Why am I concerned? Aside from BAC's miserable earnings on Friday morning most of the big reports were much better than expected. Yet investors are selling the news. Intel's report, which was very strong, sent the stock much higher but shares failed to hold the gains. JPM has sold off from its highs. GS beat by an extra $1 billion and sold off. This season investors want to see sales growth not just cost cutting to make the bottom line.
This week could surprise us and investors could start buying the news but I doubt it. The end of October is the end of the fiscal year for many mutual funds and the mentality could have changed to protect profits first and that means sell-the-news! Given the market's gains you could argue that a great earnings report has already been baked into these prices. If the first two weeks of earnings can't produce a bigger pop for the market then the second half of earnings season could be trouble.
Lately our theory has been that money managers would continue to chase performance through the end of October to maximize their results as they try to catch up to their peers and the major benchmarks. Thus far that theory has been working. The rally could fall victim to its own success. As we get closer and closer to the 1100-1120 zone, a major target for many investors, we could see more and more investors selling to lock in gains. Overall our bias is still bullish. The trend is your friend, right? We need to be cautious here. More than that we need to be guarded. Guard any gains you might have. Consider taking some money off the table now or as we near 1100 on the S&P 500. Or consider raising your stop losses. In all honesty I'm surprised that Friday wasn't worse given BAC's results and the consumer sentiment numbers.
Yes, we still have economic data to worry about. Earnings will continue to hog the headlines but Friday's consumer sentiment data was worrisome. Economists were expecting anything from a very small decline to a small gain. September's consumer sentiment was a new relative high at 73.5. October's preliminary reading fell to 69.4. Consumers are still worry about job security. That's going to translate into increased savings and less consumer spending. This week I would keep an eye on the Producer Price Index (PPI) on Tuesday morning and the Federal Reserve's Beige Book report on Wednesday.
Technically I'm also concerned about potential resistance on the small cap Russell 2000 index and the Dow Jones Transportation index. Not only are these key market indices but they're also measures of sentiment. If investors start selling the small caps then they're growing concerned about the future. Historically investors like to see the transports confirm a market rally and if the transports stumble it will be another reason to turn defensive.
In summary the trend is still up but the rally looks tired. Short-term I'd look for a pull back. We have several clues to keep track of as we measure the health of the market. Consider reducing your risk by either raising your stop loss or reducing position size.
Chart of the Russell 2000 Index:
Chart of the Dow Jones Transportation Index:
Chart of the S&P 500 Index:
LONGER TERM OUTLOOK
Previous Comments on my Long-Term Outlook:
My long-term outlook has not changed. I still expect the economy to see a double-dip, "W"-shaped rebound with the second dip in 2010. Lousy consumer spending, rising foreclosures, and lagging job growth will be the main culprits. A few weeks ago there were some comments out of the U.S. Treasury concerning foreclosures. The Obama administration's HAMP loan modification program can only help a certain number of homeowners and one official said that even if the HAMP program was a total success we should still expect millions of new foreclosures. This only reinforces my own belief that we will see another tidal wave of foreclosed homes in 2010. Some analysts are forecasting upwards of six million foreclosures in the next three years. What is that going to do to consumer confidence and consumer spending? It's not going to help! You can review my long-term outlook here. It's the second half our my "Two Months Left" commentary.
~ James Brown