This Market Has Issues
This is a market with more issues to deal with than Robert De Niro in Analyze That. Let's cover some of them:
The dollar has been weakening dramatically against most major currencies, and that's caused the U.S. Dollar Index to see the lowest level since the heart of the Asian Economic Crisis in 1998, as the chart below shows.
Until very recently, this has been viewed as a positive because it makes U.S. goods more competitive on the global stage. While that may be true, in order to export goods you need to have a buyer. Those countries that theoretically would buy our more competitive goods are also in an economic malaise, and as a result, demand may remain weak no matter what the price of goods is because of currency swings.
At this juncture, the dollar's weakness has recently been seen as a negative market influence. That's true, but what if you get a wicked bounce in the currency, which could happen at any time, given the oversold condition? A sharp turn (even if temporary) could provide a catalyst for stocks to bounce, especially given the recent string of down days.
The dollar's decline is more than modest and has created a very oversold situation:
The Terror Alert
The color-coded terror alert system was upgraded to orange this week. In my view, terrorism is something no one can prepare for. As stocks work off the overbought condition, an upgrade of this risk means a positive catalyst isn't too far away as the ultimate downgrade is greeted with a relief rally.
The Overbought Condition
The argument that I (and others) have used over the past two weeks against aggressively buying stocks has been that the market was overbought and up against trading range resistance, as the chart below shows. Both provided a perfect time to find some reasons to take profits.
The dollar's decline, the terror alert status and SARS have provided that excuse for normal and healthy profit-taking from an overbought condition. How far could stocks pull back before seeing some sustainable strength? According to the new-high/new-low indicator I outlined last Wednesday, the pullback could be about 10% over the next couple of months. That would bring the S&P 500 back to a support area right around 855. Frankly, I would be surprised if stocks retreated that much, given the strength in the recent rally, so a move back toward 875 is more likely.
Either way, the market appears to have embarked on the process of working off the overbought condition and the negative issues around the market could become positive catalysts once the market is positioned to bring back confident buyers.
The market is in the process of working off its overbought condition:
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