We are a little more than two weeks into the third quarter earnings season. Thus far about 80% of the companies that have reported have beat Wall Street's estimates. Yet it's not good enough. There are a few standouts but for the most part businesses are still beating the bottom line due to cost cutting than true improvement in sales. It could be selective memory but there seem to be more companies raising guidance this time compared to the last earnings season but investors are just shrugging off good news. That's never a good sign.

Here's a little quote from last week's column, "A bigger warning sign could be the reaction we are seeing to earnings results. 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." My warning still holds true today. If the best results can't move the market higher than what's going to happen as results deteriorate? We will still hear from a large number of companies this week (Oct. 26-30th) but for the most part the tone has been set and the stock market has failed to move.

The S&P 500 index has produced a failed rally under round-number resistance at the 1100 level. The Dow Jones Industrial Average has failed three times at the 10,100 level. The NASDAQ composite has been struggling with the 2190-2200 level in spite of very strong earnings from some high profile companies. Last week I warned readers about a potential (bearish) double top in the small cap Russell 2000 index and the transportation index. Sure enough they're both rolling over into what looks like a double top pattern.

Chart of the S&P 500 Index:

Weekly Chart of the S&P 500 Index:

Chart of the Russell 2000 Index:

Chart of the Dow Jones Transportation Index:

Recent economic data hasn't been that great. Two weeks ago the consumer sentiment numbers were worse than expected. On Friday the existing home sales came in way better than expected and the market ignored it. A few analysts feel that the National Association of Realtors seasonally adjusted numbers are all smoke and mirrors anyway. How can the seasonally adjusted number that was released show a +9% surge while the unadjusted numbers show a -5% decline in sales? The room for error seems to be pretty large. Of course many feel that last months existing home sales were a one-time anomaly anyway since buyers were rushing to close deals to get the new home buyer tax credit before it expires. This past week also brought a surprisingly negative report from Britain. Economists were looking for the British economy to see +0.2% positive GDP growth. Everyone was shocked to see a -0.4% GDP growth for the third quarter, especially after France and Germany have already seen their GDP turn positive. Thus England remains in recession and it casts some doubt on the U.S. recovery. We'll get a look at our own GDP numbers this coming Thursday.

The trend in the U.S. dollar is down and the currency hit new 14-month lows last week. I don't know anyone who expects a true bullish reversal in the dollar but it is oversold and due for a rebound. The currency doesn't have to correct but if it does will push commodities low and that will spark profit taking in the miners and the energy stocks. These have been key sectors of leadership lately.

The last several weeks we've been working with the theory that fund managers have been chasing performance as they try to maximize any gains before their year ends on October 31st. We are now down to the last week of October. What are the odds that they buy the market now or just choose to hold and wait it out. That may be the best we can hope for right now - that the market just churns sideways. Unfortunately most of the technicals indicators and the recent price action is suggesting the rally has run out of steam is and stocks are about to contract.

I'm going to repeat my comments from last week. I would expect a correction in the S&P 500 but the index should find some support near 1,050, which coincides with its rising 50-dma and the long-term trendline off its March 2009 lows. If the S&P 500 breaks the 1,050 level then I'd look for a drop toward the 1,000 level, which should be stronger support. With the market struggling at new highs this is not a great entry point to initiate new long-term LEAPS positions. Pick your stocks carefully and wait for a big enough correction.


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