Waiting for a Resolution
The good news is that both the DJIA and the S&P 500 broke out of their respective trading ranges on Friday in convincing fashion. The bad news is that it may not mean much as ‘breakouts’ have tended to turn into ‘fakeouts’ on a regular basis in the current up-one-minute, down-the-next environment. And with the deadline fast approaching for the leaders of the EU to (a) come up with and (b) agree on the much-anticipated ‘comprehensive plan’ to fight the sovereign debt crisis, we will undoubtedly see more reactionary movements as each headline from across the pond hits the tape over the next three days.
Frankly, it is tempting to sit on the sidelines and wait for a resolution to the EU debt crisis to occur. After all, given that there is a whole lot of political wrangling going on behind the scenes in Europe and that there is a tendency for politicians to use the press to either negotiate or send up trial balloons, I’m guessing that we will see at least a market-moving headline or two between now and Wednesday afternoon.
However, as the recent run for the roses has clearly demonstrated, the stock market is a discounting mechanism for what is expected to happen in the future. Remember, by the time that everyone in the game is on the same page and able to relate the drivers of the market, the game’s focus tends to change. This is due to the fact that once EVERYONE understands what is happening, EVERYONE has, more than likely, positioned themselves for the current environment. This is why it is so important to watch the sentiment indicators. In short, when the crowd is overly negative, it means they’ve already sold.
I’m of the opinion that ‘the great save’ seen on October 4th may have acted as the proverbial ringing of the bell that things had gotten out of hand. While I remain skeptical about the action on that day, the action since then is hard to argue with. Thus, I’m going to opine that the rally since the low on October 4 represents the discounting of a couple things. First and foremost, that Europe’s leaders will take a page out of the U.S. crisis handbook and find a way to restore some confidence in the debt markets across the pond.
The other thing that stocks appear to be ‘discounting’ right now is the fact that the recent economic data in the U.S. has not been nearly as bad as one might have expected. This is not to say the folks at ECRI are wrong on their call for a recession in the good ‘ol USofA. No, it just means that for right now at least, the data shows the economy to still be in a slow growth mode. And as such, the recent decline in stocks may have been ‘good enough’ to discount a slowdown.
I know I’ve talked about this more than once lately but there are three very bullish issues to keep in mind right about now. First, the analysts at Ned Davis Research tell us that if a waterfall decline of -18% on the S&P 500 is NOT accompanied by a recession; the market tends to move higher after the initial low is eventually breached. And in looking at the charts, we see that the August 8 low was indeed exceeded on October 3 and 4. We should also note that stocks have moved up smartly since that time. Thus, if the economy can avoid a recession, one can make the case that we’ve seen the lows for the current decline and that the market is likely to move higher in the months ahead.
Another item to stay focused on right now is the calendar. Let’s not forget that the seasonality favors the bulls from November through April. Actually, history shows that buying the lows of October (which can really only be done safely with a healthy dose of hindsight) and then holding through February is a VERY profitable approach to trading the market.
And finally, we need to remember that a great many mutual funds use October 31st as their fiscal year-end. Thus, if there was ever a time in which it made sense for a whole bunch of managers to put whatever cash they have lying around to work in their faves, this would be it. So, let’s not forget about the window-dressing game over the next week.
With all of that said however, the bottom line is the primary driver of the action this week is likely to be the countdown to the ‘comprehensive plan’ due to be unveiled on Wednesday. So, with the clock ticking, we will continue to monitor the headlines 24/7.
Turning to this morning… All eyes remain on Europe this morning as weekend meetings amongst EU leaders appeared to be productive. However, the Wednesday deadline looms and Germany’s parliament must approve any plan before it is presented at the summit. Also in the news, Europe’s preliminary PMI reports showed ongoing economic weakness while Caterpillar’s earnings were impressive. Stock futures are currently pointing modestly higher.
On the Economic front… There are no economic reports scheduled for release in the U.S. before the bell today.
David Moenning
Editor: The Daily Decision
