Friday, November 20, 2009

Up or Down from Here? YES!

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Since late September, the common theme in my stock market forecasts has been for a 7-17% decline lasting well into November with varying small rallies along the way. You can click on the following links for more detail. Storms Brewing for the Stock Market The Dow at 10,000: Is It Time to Celebrate? We were fortunate enough to nail the low in early October, the ensuing rally from there and then the final peak mid month. The market cooperated with the roadmap and saw a roughly 7% decline into late October.

In the previous issue of my Street$marts newsletter, I wrote about Dow 10,000... AGAIN?. I talked about a "time to rally", where stocks should bounce, but ultimately fail to exceed the mid-October peak. So far, the Dow, S&P and NASDAQ have all reached higher levels, proving me wrong, while the Russell 2000 Midcap 400 have yet to get there. I concluded that: "IF the market is to remain on the exact same trajectory as we've seen since March, the whole decline is over at roughly 7% and we are going right back to new highs for 2009. You shouldn't be surprised that I do not believe this is the case."

The question I've received a lot lately is, "Is the market done correcting and how high is it going?"

Although at the October low, the stock market had reached some fairly significant oversold readings, I was surprised at just how easily the rally caught fire. I was not expecting to see new highs just yet. By turning so strongly at exactly the moment it was doing the first really wrong thing since the bull run began in March, the market showed a tremendous amount of resilience and pent up demand into weakness. And it's possible that the pullback we saw was it for 2009.

But I am not ready to relax and embrace the rally just yet. There are still some cracks in the pavement that either need time and sideways market movement or another short-term pullback into December to fix. I am still not comfortable with the lack of volume on strong up days. As you know, volume is the horsepower of the market's engine and it's just not confirming the recent strength.

As stretched as stocks were at the recent low, they are now back to stretched again on the upside. This can be seen easily looking at the advance/decline and up/down volume data. While this can persist for days, weeks or even months, the odds favor a resolution sooner than later.

Market sentiment (the number of bulls versus bears) has been moving around like a yo-yo this year. While we saw too many negative investors at the late October low, we're now seeing too many investors positive on the market's outlook. Those indicators are usually contrarian in nature, meaning the majority tends to be wrong at highs and lows.

But I guess the thing that bothers me most right now is that fewer and fewer key market sectors are leading the charge higher. Prior technology leaders, like semiconductors, telecom and networking have yet to eclipse their October highs. The same can be said of energy and homebuilders. This can all be corrected with higher prices, but given the other concerns listed above, I am taking a "prove it to me" approach for a bit longer.

On the flip side, consumer staples, healthcare and pharma all seem to be assuming leadership roles. The problem is that these sectors are defensive in nature/ less volatile/ lower risk profiles and are generally unable to lead the market higher for more than a blip. In the past, they have followed along with other key leadership groups, but not replace them.

As I've mentioned before, this week is options expiration (3rd Friday of every month) when various derivative contracts stop trading. The trend has been for the market to remain in the direction it has been since the previous expiration, which in this case is up. It's also been a trend to see a reversal the next week, so we'll see how the bears react.

IF we get one more pullback, which I lean towards but not as strongly as I did earlier this quarter, I think it will be contained to 5-8% and wrap up by early December. The exciting part is that my models have upward projections to a minimum of 11,000 on the Dow with a chance to see 12,000 by next summer, before the next major bout of nastiness sets up. But we can talk about that in a month or so.

As always, please feel free to contact me directly at Paul@InvestForTomorrow.com with any questions or comments.
Have a very happy and enjoyable Thanksgiving!

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