Time to get back in the stock market

The stock market is looking stronger even with the turmoil in the Middle East and the rise in oil prices. The economy is clearly showing signs of improvement, especially in the improving employment numbers. The pullback in the stock market that we had been expecting appears to be another very mild period of consolidation, not much different from what we saw back in November. The S&P 500 has broken above previous resistance level at the 1300 level and now you can see buying support coming in when the S&P pulls back. The stock market has been consolidating at the 1300 - 1330 levels and appears poised to move higher. The longer term valuation target on the S&P 500 is 1,463 which we are likely to see before the end of this year.

Time to take some profits again!!

The stock market has had a nice run up since the end of November, reaching levels not seen since the summer of 2008, months before the start of the financial crisis. However, the long awaited stock market correction may be coming. While the longer term outlook is still positive, with a slowly recovering economy, an accomodative fed and strong corporate profits, on a technical basis the market my have run ahead of itself. Most technical indicators which had been in overbought territory for several weeks now appear to be turning down, pointing to a market decline. Look for a pullback to what is a fairly strong support level at the 1228 level.

Looking for a drop in market volatility

It would seem that we may be headed for an extended rise in the stock market, especially if we see a drop in market volatility going into the end of this year and into next year. I saw an interesting blog posting on a site run by Tom McClellan, the son of Sherman McClellan the originator of the McClellan oscillator. In that article, McClellan predicted that we should see a drop in stock market volatility by examining the relationship to the 90-day Treasury bill offset forward by 24 months. Here's the link to the article, http://www.mcoscillator.com/learning_center/weekly_chart/year-end_vix_plunge_coming/

Anyway I decided to examine this hypothesis further, so I downloaded 10 years of Volatility and T-bill data and ran a regression analysis on the relationship. It turns out that when you compare T-bill and Volatility there is a negative correlation of -0.55 which basically means that they move opposite to each other. (See chart below) However when you offset the T-bill data forward by 24 months, the correlation becomes 0.63, which means that they move in the same direction about 63% of time and the R squared is .40 which says that 40% of the movement of the market volatility can be explained by the movement of the T-bill from 24 months ago. Now you might be wondering why this relationship exists in the market. The explanation that McClellan uses in his article is that there is a big time lag between when the Federal Reserve engages in a monetary easing policy and when the effect is reflected in the economy. This lag between the actual Fed easing and the effect on the economy has been well documented and generally accepted by most economists. If this turns out to be the case here then, going forward into the end of this year and into next year, we should expect to see a further decline and then stabilization of market volatility at relatively low levels, which bodes well for the stock market.

The stock market is headed back up

Looks like time to get back in for the next leg up in the market. The brief stock market pullback lasted just about a week or so and amounted to a 5% correction. With Ireland now having agreed to an EU-IMF bailout loan package it would appear that EU fear card is now off the table. That said, the US dollar looks ready to resume its downward move again which means that the risk trade is back on.

The recent batch of economic reading has shown an economy clearly on the mend and with the Fed still in an easing mode with QE2, all indications are that the stock market is headed higher from here. The 1,227 level on the S&P 500 has been a stubborn resistance point, but once it gets past that look out, 1,350-1,400 does not look out of reach.

Taking Some Short Term Profits

The stock market has had a strong run up during the past two months but this upward move seems to be slowing down a bit here. While the long term macro economic environment remains favorable for the market, it may be prudent here to take some profits.Some of the signs pointing to the short term market weaknesses are from the uncertainty on the market's reaction to the aftermath of the US mid-term election, technical indicators which are overbought (stochastic and MACD) but now starting to turn down and overwhelmingly bullish sentiment from small investors. I'm not looking for a major decline since my market timing model is still indicating a positive long term trend but look for a quick, smallish 5% - 8% pullback to the 1,100 level for the S&P500 index.

BUY signal triggered

I've been developing a stock market trading system off and on for more than ten years, and after completing the review and back testing of data, I now have created a reliable indicator. This system is comprised of several leading economic indicators, the investor sentiment readings and stock market price behavior.


This system has also just triggered a BUY signal. Keep in mind that this is not short term day trading signal but a medium/longer term (lasting several months to years) trend following system. The previous BUY signal was triggered in July 2009 and a Sell signal was given back in May 2010. If you have any interest in buying into the stock market at this time, my recommendations would be to focus on the emerging markets like Brazil, Chile, China, Australia, Korea and India. For long term investors that want to take advantage of the equity market you would want to allocate a significant portion, around 70% to emerging markets and a smaller amount to domestic U.S. stocks around 20% and 10% to inflation protected bonds.

S&P500 Index held support at 1010 and momentum is now turning positive.