Stock Market Getting Tired But Higher Prices Still Lie Ahead

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

In early February I contributed a piece here entitled, Bottoming Process Continues, where I made the case that stocks had either just bottomed or were about to, and that would lead to another strong run to new 2010 highs. I wrote similar articles in my newsletter, Hang in Bulls... Bears Almost Done that was followed up with Bottoming Process Continues Building. After forecasting a 4-7% pullback in January (we saw 8.5%), I was very confident that the decline was close to ending and a new leg higher would ensue, carrying the major averages above their 2010 highs on the way to Dow 11,500 - 13,000 when the weather turned warm.

Although rare, it's always nice when the market perfectly cooperates with your thought process and even nicer when your clients are the beneficiaries! So here we are, back at the highs and everything looks mighty rosy again, right? Well... kinda, sorta.

My forecast for the Dow remains in play sometime between Memorial Day and Labor Day, but the very short-term is a bit cloudy with the worst volume pattern since the bull run began. Volume is so important as it is the horsepower of the market’s engine. The stock market can fall and fall on light volume, but sustainable rallies have always required increasing volume. Stocks have rallied in almost straight line fashion, but are in need of a quick pause to refresh. My favorite analogy is that of the great steakhouse dinner.

Between the appetizer, salad, steak, various sides, wine and dessert, you can barely stand at the end of the meal. And before it's time for your next feast, you must digest the food. Markets work in similar ways. After a big rally, the market has to digest to make room for the next meal. The bigger the rally, the longer the digestion. In the current case, all the market needs is a good, short-term cleansing before it's ready to eat again.

I imagine that whatever weakness we are going to see should be right ahead of us. How long it lasts and how deep it goes are questions that will be answered along the way. In the most bullish case, we'll see a few nasty down days that look and feel really bad, but end quickly. But if investors don't increase their level of worry and don't become more concerned after a few days like that, we'll probably see a deeper and longer pullback. The first level I am watching is 1120 - 1125 on the S&P 500 and 10,300 - 10,400 on the Dow.

Should this pullback materialize, and it rebuilds a little worry in the market, I think it can be bought with both hands for another move to new 2010 highs during the second quarter. As I've mentioned before, one of the most important things to watch is sector and index leadership. Before any "real" correction (10-20%) sets up, there should be some clues here from what's leading and lagging.

Over the past year, with all the cheap and easy government money being thrown around, the financial markets have done nothing seriously wrong to jeopardize the bull run. But with Bernanke & Co. already beginning to pull the punch bowl by ending their trillion dollar purchase of mortgage backed securities and the Obama administration raising taxes in 2011 by letting the Bush tax cuts expire, the markets are much closer to another problem later this year and into 2011.

Please feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC
http://www.InvestForTomorrow.com