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No, Really... a Key Point



The big news of yesterday was the 20-point surge in the Consumer Confidence reading.

Obviously, entering into a war had a depressing effect and winning a war had a euphoric effect on the consumer -- as it probably should.

Some were surprised because the overall equity market didn't have a more positive response to such good news. The truth of the matter is that a good chunk of the good news is likely factored in for the time being. There is enough momentum and fundamentally good news to combat a "disaster scenario" for now. But in my view, the combination of gains over the past seven weeks and technical condition is likely to cause a pause here at trendline and price resistance.

The S&P 500 (SPX) is up 14.6% since March 11 -- that is a pretty significant rally that has brought the market up to the upper end of the trading range that we have been talking about for some time. How did that happen?

· Winning a war in just over a few weeks is a stunning achievement and the speed of success forced shorts to cover.
· Better than expected earnings that were not brought down so much during the quarter that they could only beat expectations. The earnings reports have been solid relative to expectations.
· Absent an imminent military operation, consumers and businesses were perceived to have opened their pockets to spend. The consumer confidence report seems to support this viewpoint.
· Credit spreads have experienced a significant tightening as Brian Reynolds has so eloquently outlined over the past month. That in itself takes out the disaster scenario for now as well.
· Investors, individual and professional, have moved money out of bonds and back to stocks due to historically low yields for most fixed income investments and a greater confidence in future economic growth.

The gains resulting from the above points (whether right or wrong) have been dramatic and leave the market at a key point. I don't normally believe that each tick is a "key point," but if winning a war, getting better than expected earnings, asset allocation switches and a huge uptick in consumer confidence only gets the market to the upper end of the trading range, I am hard pressed to figure out what would bring in enough natural buyers to drive the market through trendline and price resistance, especially now that the earnings season is nearly over.

There are enough positive influences that suggest the doomsday market scenario has been put on hold. In my view, moderate growth is a positive surprise when expectations are for a terrible fundamental environment -- but not AFTER a 15% move in the SPX. In addition, the technical picture has become more important due to the rally.

Near-term Picture

Over the last month I have been talking about and graphically outlining the trading range environment in the S&P 500. That is a neutral environment, which means until it changes, overbought should be used as a sell signal and oversold should be used as a buy signal.

Just to remind you, in a bull market, overbought becomes more overbought and is a poor sell signal and in a bear market oversold becomes more oversold making it a poor buy signal. Right now the 14-period stochastic is overbought in a neutral market suggesting that at best there is likely to be a pause. At worst, the SPX could move back toward the lower end of the range where it would likely become oversold and therefore bought.

Source: Baseline

Intermediate-term Picture

As you all know by now, I like to look at more than one time-frame when coming to a conclusion, whether near or intermediate-term. When I step back and take a look at the weekly chart of the SPX with a 14-period stochastic, I see that the downtrend continues to be in place and the market is at an overbought level that has generated declines over the past three years.

Source: Baseline

Both time frames agree that this would be a good time for the market to consolidate the recent gains. Remember, the technical rule is that overbought in a downtrend is a sell signal until the downtrend is broken and the market enters a new bull phase.

A new cyclical bull market could happen, given the improvement in the fundamental backdrop. But if you are putting fresh money to work right now, you are making that bet without yet breaking through overhead resistance.

I suggest using very tight stops on long trading positions and waiting for either a massive volume break above both price and trendline resistance, the overbought condition to be worked off or a move back to the lower end of the range before putting new money to work.

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