Yesterday, I outlined how the market is no longer overbought and extended. Those were the two main reasons that I felt it would be a mistake to buy after a 10% ramp in just a few days last month. This is important because there is a new dynamic that has positive near-term and negative intermediate-term implications. The new dynamic is that the War in Iraq appears to be giving the economy and corporate America a "free pass" to get away with dismal news.
Near-term: Possible rally back to upper end of trading range.
The markets are entering a period that I would normally consider to be very risky for the equity market. Economic reports and negative pre-announcements from corporate America would normally be a major negative this far into the economic recovery and with interest rates so low. The War changes that dynamic because there is now an excuse everyone can use in a general way to explain away poor results.
The most recent examples were the ISM and Factory Orders reports. Both showed dramatic weakness, but bond yields went up. Why? The rationale is: "What would you expect in a war time situation? And it will be dramatically reversed once the conflict is over." Frankly, I think the weakness in the economy and profits isn't solely the result of the war, but it is enough to take away the bite of poor results for another quarter. That is good news from a trading perspective.
Intermediate-term: Nothing has changed in the trend.
Yesterday I attempted to outline that while the market may trade higher over the near-term, I remain cautious over the intermediate-term. That's because the market has caught an Iraq-related bid for the near-term, hoping -- despite negative economic and profit results now -- that resolution of the conflict will kick-start the economy and the forward-looking profit picture.
I am not so sure. And what would happen after the "free pass" has been used and results remain modest at best once the Iraq conflict is over? Stocks aren't cheap, consumers are retrenching and represent the vast majority of economic growth, there are more geo-political issues than Iraq and the trend remains negative (see chart below).
The expected near-term rally should lift the market back to trend line resistance, but there is going to have to be a reason for significant gains from there and frankly, I just don't see it. The market may act well near-term as I indicated above, but from the intermediate-term standpoint, the trend hasn't even changed from negative to neutral yet.
That keeps me in the "neutral at best" camp looking past the current rally.
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