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Can the Hope Rally Continue as Europe Teeters?


Markets rally on hope for a European settlement. Of course, this could all fall apart and set up a Lehman-like crash with the potential unraveling of Europe.

Last week I wrote: "Today we stand at a most important crossroads for the global economy and for major US stock market indices like the Dow Jones Industrials (DIA) and S&P 500 (SPY). The endgame in Europe appears to be at hand, and the successful or unsuccessful resolution of this crisis will determine the investment climate going forward." (See Global Economy at a Crossroads; Expect More Volatility Ahead.)

That perhaps is doubly true this week, as European leaders meet in a two-step summit on Sunday and Wednesday and global markets await the outcome. The recent rally has been a "hope rally," fueled by hope for a settlement of the European crisis, and if this is realized, we will likely see this develop into a strong seasonal rally into the end of the year. If not, we are looking at the potential for an international "Lehman event," and the associated pain that will accompany the unraveling of Europe.

On My Wall Street Radar

S&P 500 (SPY)

Courtesy of

In the chart of the S&P 500 (SPY) we can see how the impressive rally of the last three weeks has broken through resistance levels, and now the 50-day moving average is turning up and the index is within 3% of the 200-day moving average (red line) that is widely regarded as the demarcation line between bull and bear markets. The index is 8% below recent highs, and that level could be recaptured if the 200 day moving average can be crossed.

So for now, this is a bear market rally that will live or die based upon the events in Europe. Seasonality favors the continuation of the uptrend into the end of the year and technical indicators now point to higher prices ahead for the short term.

The Economic View From 35,000 Feet

The week's news was mixed, as earnings have been relatively positive with the exception of some major misses like Alcoa (AA), IBM (IBM), and Wells Fargo (WFC).

Economic reports continue to show slow growth, with the Fed Beige Book confirming that, along with leading indicators and a positive reading from the Philadelphia Fed Index, which jumped to +8.7 from a previously reported -17.5.

The bad news continues to come from Europe with riots in Greece and downgrades of Spain and Italy. Contradicting the positive Philadelphia Fed Index, the Empire Manufacturing index showed continued contraction, while China's GDP growth continues to slow and the Shanghai Index is in a solid bear market. Finally the Economic Cycle Research Institute's index continues to forecast recession dead ahead.

This week come important economic reports, with the Chicago Fed today; Case/Shiller Housing Prices and consumer confidence on Tuesday; jobs and third quarter GDP revision Thursday; and income, spending, and consumer sentiment on Friday.

Bottom Line for Stock Market and ETF Investors

Bottom line is that the global economy is slowing, the US economy is near flatline, and there are serious problems with sovereign debt around the world. The world will be watching Europe this week. A resolution could lead to a strong year-end rally, but even optimism over a settlement of the Greece problem must be tempered by the fact that Italy and Spain lie waiting, perhaps in the new year. We can expect more volatility ahead.

Editor's Note: Read more from John Nyaradi at Wall St. Sector Selector, a financial media site specializing in exchange traded funds, global markets and economic analysis.

Twitter: @WSSectorSelect

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No positions in stocks mentioned.

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