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Surprised to
see to back-to-back, late-in-the day rallies over the last two days of
this past week? We're not. Oh, that's not to say we had a Nostradamus-like
premonition, but it wasn't a surprise either..... the underlying conditions
ripened the rally potential.
At any rate,
the reason for the move - and the lesson it reminded us of - is
one that deserves to be explored today. After that, we'll actually take
a look at the chart of the S&P 500 and make some predictions.
Before we get
to any of that, however, we've got one blog post to suggest....
"Investment-Worthy
Trend: Road and Rail Proves All It Needs To." If any of you thought
the economy slowed down in May and June, you'll want to take a look at
these charts and earnings figures. These stocks are quickly becoming one
of the market's best deals.
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Why
the Market Does What it Does |
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The
S&P 500 managed to gain 4.5% last week, overcoming a big Wednesday
pullback, and more than offsetting the previous week's 1.2% loss.
 So
what happened in the meantime to turn investors back on again? Economy?
No, the new unemployment claims figure is back in the 'too high' area,
and real estate appears to be crumbling again. Good earnings news? No.
Though we saw plenty of encouraging surprises, we saw a fair number of
letdowns too, from Yahoo, Google, and others. [In terms of beats/misses,
this earnings season is about the same as all the rest.] Cheaper oil?
No, if anything, the brewing storm in the gulf is going to tighten the
supply for a few days, and push prices higher. Confidence in the federal
government? No, Obama's polling at near-record unpopularity, and the
bulk of his decisions are being considered 'business unfriendly'.
So what gives?
Here's
why the market rallied so well last week, and for that matter, why
it's up 8.8% over the last three weeks..... because investors were just
ready to buy, choosing to see more value in stocks than liability.
Don't laugh
- it's the truth. Nothing else that is 'supposed to' drive stock
prices changed during that time. Investors just decided it was time for
a rally.
Some of you
will believe that, some of you won't, and some of you will consider the
idea over time before making a decision. Whatever group you fall
into though, you should also stew in something not that we said,
but something Benjamin Graham (the founding father of the "why the market
does what it does" theories) wrote long ago....
"In the short-term,
stocks are a voting machine and in the long-term, stocks are a weighing
machine."
The short-term
'votes' are swayed by the ebb and flow between fear and greed. Since they
are always changing though (largely due to factors that actually have little
effect on the market), stocks are rarely pointed in the same direction
for very long.
What being 'weighed'
in the long-term is earnings. Eventually, even if only temporarily,
stocks are valued appropriately. This may only occur a few times per year,
if that, but it's why long-term 'buy and hold' investors are willing
to hang on even when the environment is testing their confidence.
Or to put all
of this succinctly, the April/June pullback was the result of overbaked
bearishness (fear), which stemmed from excessive confidence (greed) that
swelled up in February and March.
Undoubtedly
we'll see greed/confidence peak again in the foreseeable future, at which
time stocks will be back to an overvalued status. Guess what's going to
happen then.... another pullback.
 All
those up and down swings? Those are the 'votes' Graham was talking about.
With each of those short-term swings, however, the S&P 500 has or will
hit the 1150-ish area, which - based on earnings - is what we see
as an appropriate valuation for the broad market. Even if it's only there
for a short time, getting there at all validates Graham's idea that
over the long haul, the market does get it right.
Yes, the earnings
outlook is always changing, but never to the degree that all these wild
swings in stock values imply. True earnings-based investors only
need to look at the market and the earnings data on a weekly basis, and
really,
a mere monthly view may be adequate. All the gyration in the meantime is
just a lot of fluff and volatility, mostly induced by the media that preaches
a 'take action now' mentality with every shred of news.
We've said this
before, but in light of everything discussed above, we'll repeat our important
message today - investors who can distinguish between long-term trends
and short-term trends, and trade accordingly, are equipped to outperform
amateurs and professionals alike. That's why we focus so much on our
short-term timing tools like breadth and depth, and continually look at
the market's overall P/E ratio, even though we're usualy speaking to long-term
investors .
Anyway, as far
as the market is concerned....
Given the current
bullish momentum, and the growing degree of optimism because of
the recent gain, we're looking for stocks to continue upward. In an ironic
twist though, by the time the S&P 500 reaches levels that are high
enough to convince everyone that the market is in a recovery mode,
the index will also hit a couple of major headwinds.
 The
first
headwind is the potential resistance at the 200-day moving average
line (green), currently at 1113.
The second
headwind is the upper 50-day Bollinger band, currently at 1140, and falling.
By the time the S&P 500 hits the 200-day average line's area around
1113 though, the Bollinger band may be right there too. (Bear in mind
these potential ceilings are rarely exact ceilings - we want to watch closely
anytime the indices are around major milestones.)
While Bollinger
band are generally not part of our normal technical fare, they've proven
to be reversal points for almost all the major trends since March
of last year, or at least the guideposts in cases where a reversal did
not immediately materialize. You can see this so some degree on
the nearby chart, but to really appreciate how important these band
lines have been over the last year and a half, check out this full-screen
chart.
To be clear,
we're not saying the market's going to roll over around the 1113-ish area;
we're just watching for it here, as if it's going to happen at all, that's
the most likely place for it to happen.
Indeed, if we
had to venture a guess, based on momentum and earnings, we'd expect
a brief pause around there, and then look for the S&P 500 to gently
push the upper band higher for a few weeks. It would be quite like the
progress seen in November and March.
Let's cross
that bridge when we come to it though.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
