It would be hard to fight all the good news and momentum of the past week. The oil leak in the Gulf was slowed. FINREG as a headline risk is now past. Earnings and revenues for the quarter completed have generally been better than expected. Further, as I predicted a few days back, the bank stress tests proclaimed that all was well in European banks. The fact that this seemed to act as a positive catalyst for global stock markets tells one something about the irrational behavior of market participants. While I will admit that I have not read in detail the criteria of the stress tests, I have heard repeated criticism from reliable sources that there was an assumption that there was no risk of sovereign debt defaults (or least an omission of consideration of such risk). Regulators made this assumption despite the fact that Euro banks hold risk of hundreds of billions of dollars in sovereign debt/derivatives related to that debt. As an investor, one should be wary of the conclusion that the ultimate capital shortfall in the European banking system is around $3B....With likely continued good news on the earnings front over the next several weeks, the only headline risks appear to be in employment and GDP reports. Unless, there is a negative surprise on those counts, headline support has helped the bulls regain control of the of the stock market. As John Hussman notes in his weekly report today, the gradually deteriorating fundamentals of the U.S. economy are not likely to get in the way of technical changes in the market short term as the former are not day to day news events.
I would caution that this market has had several apparent breakouts of the trading range and is very tricky. However, on a technical basis, the market is looking stronger. The upper trendline drawn on the S&P 500 ETF in several previous posts has been broken to the upside, as has the 50 day moving average. The next challenge for price is the 200 day moving average just above an S&P level of around 1110. In terms of position, I think the market moves of the next few days will provide an indication of short term further momentum with clear levels to be used as support and resistance. Personally, I would not be short unless we see the 50 day moving average and former trendline violated to the downside. One could take a long position right here with those as your stop points or wait for a hold in price above the 200 day moving average. Of note, I have repeatedly pointed to the NYSE Summation index (a measure of market internal strength by advance and declining issues) as a clue to when the correction might end. This indicator has stayed negative throughout the correction off the April highs. It is now above "0" supporting the breadth of the aggressive recent move upward. Thus price momentum and market internals are now supportive of an end to the correction.
I word of warning, however. I am not a believer in the predictive value of stock market moves to necessarily provide a 6-month guide into our economic future. After the bear market began in early 2008, the S&P 500 went back above the 200 day moving average twice in May 2008, before then descending on a long term downward path. Clearly, early May 2008 was a dangerous time to get back into the market without a risk management plan. Even for long term investors, I would tread similarly here back into the market with a defined risk (i.e. stop loss) such as the ones suggested above.
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