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Digestion versus Indigestion


Last week reinforced the "good enough" scenario I have been writing about since the end of the second quarter. Despite two presentations by Fed Chair Greenspan, a good chunk of the S&P 500 reporting quarterly results, and a lot of volatility - there was very little progress made in either direction. That trend of higher volatility with limited progress should continue for the next few weeks as mixed results relative to higher expectations come from economic and corporate releases.

Near-term Outlook: The market seems to remain in a transition phase from the perception the economy should improve to ascertaining the integrity of real economic and therefore corporate earnings improvement. The S&P 500 (SPX) is still in the process of digesting the gains of move off the March low. This process is further along than it "seems." As the chart below suggests, the S&P 500 has not made any progress since the June 17th high (Exhibit 1). In addition, for the first time since early July, there are more oversold than overbought components of the S&P 100 (OEX). This suggests the "good enough" environment has been underway for a month.

Exhibit 1 - The "churning process" continues on the daily chart

Intermediate-term Outlook: The market continues to consolidate the breakout from the clearly defined trading range. How it consolidates the significant rally that took stocks out of the range (Exhibit 2) depends on how it consolidates the gains. In English, a vibrant market works off the near-term excesses by going sideways vs. a pronounced sustainable drop. So far, so good, but the consolidation process has a bit more to go.

Exhibit 2 - Weekly SPX chart shows breakout consolidation

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