The economy remains weak, earnings are poised to continue contacting for the 6th quarter in a row yet stocks has broken out to new record highs in August from an important technical base. Without a strong rebound in earnings, we have a price-earnings multiple expansion stretching the faith of many investors. Option trader optimism in terms of call option buying seems to have peaked and the Advance-Decline ratio of stocks has fallen to levels that raise the risk of at least a mild correction.
Our belief is year over year comparisons with the commodity price rebound will allow earnings to gradually catch up to price into the 2nd quarter of 2017 allowing another 3% rise in the S&P to the mid-2200s with potential for the upper 2300s at a later time. Shorter term it’s likely the election news climax of narrowing Presidential polls along with this momentum pause may prevent strong stock market gains until the 4th quarter.
If oil prices can move above a barrel there may be enough support for stocks to again creep to new highs short term. Conversely, if oil prices falter on the chimerical view that an OPEC production freeze will keep prices up without lost market share consequences, then stocks will correct. Currently, oil has rallied over the past 13 days and is holding below the important - resistance zone. A move above that zone is where many technicians are expecting an inverse head and shoulders breakout for another leg up. Rising inventory and production levels by year end imply that any further rally will be highly speculative.
Related podcast interview:
Kurt Kallaus: Modest Cyclical Upturn Underway