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Update: What Might Keep Profit Takers Away?


Three things need to happen before profit takers step in.

My firm just completed two straight quarters with 10% or better returns in the S&P 500 (SPY). Most investors are very happy with their portfolio right now. In fact, many are wondering whether they should lock in that happy feeling and take some profits.

In fact, we wrote last week that we think the profit takers will find excuses to step in if any of the following occurs:

1. Earnings season is a complete success – no excuses! It must be an unmitigated success.

2. Economic indicators must be solid – not spectacular, just solid. We could even get away with mixed results if the most important indicators were good.

3. European news must quiet down – and they must avoid really bad news. Bad news is ok, but just not really bad news.

So, if these three can be avoided, the rally will probably continue. Let's examine where we have come in a week.

Earnings season has been fine – even good. 69% of S&P 500 companies have had good results beating estimates compared to 58% in the prior quarter. Analysts are also raising earnings estimates for the S&P 500 for the remaining quarters in 2012 based on guidance from recent earnings. I think the market is passing test No. 1.

Economic indicators have been good enough, but the jobs number this Friday will be interesting. The ISM manufacturing numbers released yesterday morning were very strong, surprising analysts. The ISM number is a leading indicator, and when leading indicators are surprises to the positive, the market tends to react strongly. The GDP number was disappointing to most at 2% growth. But 2% growth still feels ok to many, and some of the key measures were closer to 2.5%. But GDP is a lagging indicator. Overall the indicators have been good enough. However, the jobs number hangs in the air on Friday as a potential ax on the market's neck.

The news from Europe has continued to be bad. All economic news out of Europe is bad. But the real litmus test is how bad. In this case, we got confirmations that Spain and other countries in Europe are in recessions. But we already knew that... or suspected it anyway. The data just confirms it. Manufacturing output shrank and unemployment climbed in Europe in the latest readings, but we are looking for big problems. Ultimately, we can only give this measure an incomplete grade.

Overall, we think the profit takers are still in the wings, waiting to step in and take profits... but at least two of the impediments to profit takers are still hanging out there.

Editor's Note: For more from Wayne Ferbert, go to Buy & Hedge ETF Strategies.
No positions in stocks mentioned.
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