Economic Numbers Improve with Earnings Around the Corner

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Let’s jump right into the technical picture of the market. Things were up stronger last week as 70% of the stocks in the S&P 500 were either in basing or advancing patterns. That figure has been choppy over the past several weeks, however, with 70% of the stocks in the S&P 500 being in sound shape technically the bias currently goes to the bulls. 

The short term picture is a little weaker. The market is off today, but it has been off on Monday’s with regularity. There was a negative divergence in the market last week. The Dow moved to its recent highs and the other averages did not confirm. The S&P 500 flirted with its break out level but the NASDAQ and Russell 2000 did not threaten their respective resistance levels. The market remains split. Stocks that are in sound shape technically are being bought aggressively. Stocks that begin to roll over are being sold aggressively and producing inferior returns. Near term support levels for the Dow/S&P 500/NASDAQ/Russell 2000 are: 1450/13,490/3125/834. There aren’t any real danger signs right now technically. There are always some black clouds off on the horizon. If the short term levels give way then we need to keep our eye on the intermediate term support levels. Intermediate support levels for the major averages are 1429/13,365/3079/830. If these levels give way the selling will intensify and we will have our first major sell off in quite some time. If I warn you about the downside numbers I must also alert you to signs that the rally will find new life. Resistance on the major averages is as follows: 1475/13,365/3200/870.

I have been talking for a while about the importance of oil prices and how they impact the economy. The market ran into trouble earlier in the year when energy prices reached an unsustainable level. When oil prices spike too high they put a damper on the entire economy. I have been saying for the past several weeks that we are far enough removed from the top in energy prices to begin to see positive surprises from economic releases. Last week we received several economic numbers released that were in excess of expectations. Housing related data continues to be strong. Mortgage application data released last week sparked another rally in housing stocks. Mortgage applications were up 39% year over year. Continued reduction of inventory levels and record low mortgages have created an extremely favorable environment for housing stocks. Banks and other financials have also performed well in this environment. 

Information on Leading Economic Indicators has been favorable for the past few weeks. Monthly LEI data through the end of September has reached a new cycle high. Last week we saw an improvement in consumer sentiment. Both manufacturing and non-manufacturing ISM data surprised to the upside. 

We have all been wrestling with the developments in Europe and the impact those developments will have on our economy and markets. The picture from Europe has improved significantly. LTRO, OMT, QE and other central banker actions have had a significant positive impact on European markets. The credit default swap readings in Europe have improved significantly all year. These facts have played a large part in the rally in 2012.

What next? We are entering Q3 earnings season and increased talk about the fiscal cliff. These are factors that need to be dealt with. There are always issues that need to be dealt with. Most of the pundits on TV were certain that last earnings season was going to be awful—it wasn’t. Those same experts are chirping away again as earnings season begins in earnest tomorrow. Some will beat expectations and some will fail to do so. There is no way around that. The fiscal cliff talk will wax and wane depending on the movement of the markets that day. I feel that all the issues are out there and to debate them isn’t really a useful exercise. If the market holds at resistance levels and bounces higher smart money is telling us that the issues of the day will be handled satisfactorily. If resistance levels give way and selling intensifies then you need to be vigilant and sell names that begin to roll over. You have the levels where the bulls and bears will battle. How the market reacts at those battle lines will tell you most of what you need to know about the direction of the market. Stay disciplined. Let your winners run and boot the laggards. Follow the Drill.

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About Thomas J Smith CFA

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