Something Isn't Adding Up

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The mood of the market remains overly pessimistic. Surveys of individual and institutional investors remain decidedly bearish. The problem is that these surveys have been bearish all year in the face of a rising market.

Are the bearish feelings going to now prove correct? Have those on the sidelines just been early or are they really going to see the market fly up in their faces going forward?

Market strategists make guesstimates/forecasts at the beginning of the year. My take on it is that they take the year end figure from the prior year and then add 8% to 12%. Well we are in that range right now. So, not unexpectedly, many strategists are predicting a flat market for the rest of the year.

But, many economic figures, after being quite sluggish for many months are just now starting to turn higher. Leading Economic Indicators (LEI’s) are showing signs of steady improvement. The housing sector has been a tremendous drag on the economy since hitting its peak in 2007. Data from the housing sector has been improving steadily for the bulk of the year and the data just keeps getting stronger. Strength in housing has a ripple effect throughout the economy. When the hammers and bulldozers shut down our economy takes a hit. When there is improvement in the housing sector the impact is felt in a variety of industries and the entire market is helped out. The homebuilding index began to rise in the first quarter of this year. Homebuilding stocks have greatly outperformed the market. As we sit Consumer Confidence has recently hit a four year high. Housing is a major contributor to this boost in confidence.

The positive surprises are filtering into other areas. Friday’s October payroll number is a case of economists just taking past data and extrapolating it into the future. 91 economists came up with estimates to create the consensus estimate. All 91 came in with a number below the actual number released. It is one thing for a number to beat consensus estimates; it is another to beat each and every estimate.

Leading indicators like housing and consumer confidence/spending have already turned higher. Coincident indicators like employment and industrial production have also moved higher. In light of this there has been no improvement in sentiment on Wall Street. Either the trend in the data is going to reverse or strategists are going to have to take numbers higher.

The technical picture of the market remains very choppy. 57% of the stocks in the S&P 500 are in either basing or advancing stages. Several areas of the market are in their own private bear markets. Do not just focus on the overall market. Keep an eye on the trees in your portfolios, the individual names. Try to determine if each name in your portfolio warrants continued membership. The market is becoming increasingly volatile and weak performers are getting hit with vicious selling pressure.

Last week the market held support but only some of the averages then rallied to close above resistance on Thursday. This created a negative divergence and we saw the market move aggressively lower last Friday. Support levels for the major averages are 1402/13,035/2959/804. Resistance levels are the following: 1436/13,300/3035/834. 

There is a divergence between the recent action in the stock market and the stream of economic data released. This divergence can only remain in place for so long. At some point the direction of the market will be clearer.  We all know the issues that concern the markets. As to what you and I think of these issues isn’t all that important. Our opinions can’t drive the market one way or the other. What we can do is get a read on the LEI’s and the overall take of the technical picture to get a sense of what direction the market will move going forward. Keep an eye on the above support and resistance numbers. How the market moves when these numbers are in play will give us a clearer picture on the direction of the market over the next several months.

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About Thomas J Smith CFA