One could tend to dismiss this week’s market move as just another short covering rally triggered by unsubstantiated rumors from Europe. Friday’s sell-off in the face of fairly good unemployment data bolsters that premise. So why do I feel we have further to go on the upside?
Call it a feeling; call it a hunch, but the market’s action over the last week or so makes me think that the rally is not quite over. I noticed that during our recent break of the 1,100 level of the S&P 500 Index (The Low) on October 4th, the number of new lows was less than the number of new lows in stock prices registered on August 8th. And on that same day, the number of stocks above their 200 day moving average reached a low of 7%. On October 4th we registered the same 7% low (but no more), putting in a “double bottom”. This is a bullish sign.
At the same time, the CBOE Volatility Index (VIX), the investor fear barometer, failed to break out to new highs, despite a lower low in the market. Finally, despite the string of bad news out of Europe, many of the European indexes did not make new lows. Now I know that all this is a bunch of mumbo jumbo to most of my readers. That’s okay.
The takeaway is that the internals of this market are starting to show some positive divergences. At the very least, I would not be shorting this market quite yet if I were you. Certain European leaders are making noises that sound like some kind of definitive deal is in the works to resolve the financial crisis among its members.
Stateside, the economic data seems to be turning neutral as opposed to negative. Weekly retail sales were a positive surprise, the economy gained more jobs than expected and there is an outside chance that investors are too negative on the upcoming earnings season.
Now, a little more upside does not mean that the correction is over. We are in a bottoming process. That could take a few more weeks to resolve. I recently wrote a column (“Should you be worried about October?”) where I explained that “September is usually the month where crashes occur and October is the month that ends them.”
Our recent low on the S&P 500 was 1,074. 77. Could we break that low? Sure we could, but I would be a buyer if we did. Predicting the actual bottom of a correction is more luck than anything else. I would prefer to state a range. Right now let’s say we surprise to the upside next week on some news out of Europe. The S&P experiences a sharp reflex rally to 1,225 or more before swooning once again. We fall back to the lows and maybe even break them.
I would be focusing on purchasing industrials, materials, technology, large cap and dividend stocks. I would also look at Germany as well as developed markets outside of North America such as Europe, Australasia and the Far East as represented by the MSCI EAFA Index.