There has obviously been an enormous amount of data to digest over the last few weeks. Mid-term elections, QE2, G20, and daily wide fluctuations in a variety of commodities have all taken up the headlines recently. Within this macro context I need to determine how this is going to impact the earnings prospects of companies I own or am considering buying. This research cannot be done with a blind eye to the broad trends in the market. Let’s look at some of the major trend changes that have taken place over the last few months and see if we can put last week and the weeks to come into perspective.
At the conclusion of my piece last week I cautioned, “Do not be stunned by a pullback from these lofty levels.” On a technical basis the market was extended. The move was reaching technical levels that clearly signaled a pullback. At the 1228 level for the S&P 500 the move higher was 161% (that is a textbook level that signals exhaustion in a move) of the last upward advance. The high set the day after the Fed announcement was 1227. The 1228 level provided stern resistance. Also, at 1220 the S&P move off the July 1 low of 1010 equaled 100% of the entire move down from the April high to that July low, again a textbook level for at least a pause in an advance. As we reached the highs for the year we needed a breather. So, if you put the move lower last week into context it makes sense. The market stalled out at obvious technical levels of resistance after a spirited advance. I also said “Based on the strength of the market any pullbacks should be orderly and should provide an opportunity for buying or adding to high quality stocks.”
Where do we stand now after the move lower last week? On November 4 the S&P broke above 1196 resistance and roared ahead to the 1227 top mentioned earlier. Mid day Friday the SPX traded down to the prior breakout level. 1196/1195 marked a solid near term support level. 1196 was the prior range high and 1195 is the index’s 20 day moving average. So, up to mid day Friday the pullback was sharp but still it made sense to me. The S&P found support at that level and buyers came in and took the opportunity to add to positions on the pullback. The S&P bounced off the 1195 support to close the week at 1199 and change. Makes sense to me.
Another comment I made last week needs to be examined further. “Last week the race was to pile into areas that will be the biggest beneficiaries of the Fed announcement. Going forward earnings prospects will again be the primary determinant of performance”. Cisco announced earnings last week. They beat estimates but gave poor guidance. The stock was down more than 16% the next day. For many years that would have signaled an end to any hopes for the technology sector for the foreseeable future. But, when you compare what they said to what other tech companies are saying it paints a different picture. Juniper, Oracle, and Broadcom all have major business lines that compete directly with Cisco. Those other companies reported great quarters and gave great guidance. Those companies all continue to perform well. Companies that release poor guidance will continue to be punished. Names that beat expectations and increase forward guidance move higher. Makes sense to me.
The S&P 500 was off 2.2% last week. Friday saw the heaviest selling with the index down 1.2%. The S&P posted its worst weekly performance since late August. For the near term picture to improve the index needs to work back above 1204. Some areas of support to consider are 1196, 1185 and then a critical level of support at 1177 comes into play. A move above the 1227 level signals another run for the market.
This discussion on the recent moves in the S&P 500 is to illustrate that the action over the last few weeks actually makes a lot of sense. There was a long list of catalysts that drove the market higher in September and October. Now as we near the half way point in the fourth quarter the technical picture is not as pristine as it has been in recent weeks. Regardless of the movements in the market I will continue to focus on companies that have leading positions in industry groups with attractive long term outlooks. The technical movements I discussed will give me signals as to when to reduce or increase exposure to the best names in the most attractive sectors.
