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Short-Term Pullback Likely, But Then What?

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    September 19, 2012

    Here are some of the reasons the market is likely to experience a short-term pull-back over the next week or two that could take the S&P 500 back down a bit, 3%, or even 4%, to around 1,400.

    1. The market is short-term very overbought above 50-day moving averages.


    2. Investor sentiment is at extremes of bullishness and confidence usually seen at rally and even market tops.

    Fear had started to rise a bit (bullishness decline) when the market was down for two straight weeks. But the back-to-back surprises by the actions of the ECB and U.S. Fed have fear back at an extreme low, bullishness at extreme highs.


    3. We are in an often negative short-term period, the month of September and the quarter’s quadruple-witching options expirations week.

    As the Stock Trader’s Almanac says. “September has opened strongly in 12 of the last 16 years but closed weak”. And “September Triple-Witching Expirations week can be dangerous, and the week after is pitiful.”

    But if a short-term pullback takes place that alleviates the short-term overbought condition, and the negativeness often seen in the last half of September becomes history as the market enters October, then what?

    With global economies slowing all year, S&P 500 earnings growth slowing all year and projected to be negative this quarter for the first time since the last recession, it’s obvious the market’s unusual rally and rise in bullish investor sentiment since the June low was driven not by normal market forces but entirely by the promise of ‘whatever it takes’ from ECB President Draghi, and the U.S. Fed’s repeated assurances that it would come to the rescue “if needed”, and now the follow through action on those promises.

    Investors are positive that the results of those actions will be the same as the market reactions to QE2 and operation twist in 2010 and 2011.

    Perhaps, but was the effect of QE3 already factored into the market?

    As I noted in Saturday’s blog, “The previous stimulus efforts did not take place until the housing industry was nose-diving again, and the stock market was down sharply and needed rescue to prevent it from entering bear market territory. (Actually it was already in a bear market at the time of QE1).


    But this time the Fed took its latest aggressive action at a time when the housing industry is potentially recovering on its own, and when the stock market is robustly positive, has already spiked up 13% since its June low in anticipation of the action, and with the S&P 500 already at levels most bullish analysts had as targets for the full year.”

    In the background, the initial euphoria created by the ECB’s decision to offer unlimited bond-buying to troubled euro-zone countries to ease their debt crises is wearing off. It’s becoming more clear that there are still disagreements to be worked out that could delay implementation for several months.

    Will the initial positive reaction to the Fed’s QE3 effort experience the same fate?

    Will investors begin to wonder why the Fed took the action this time, with the market and confidence already at new highs. Could it be that the Fed sees something coming down the road that is not yet in the public domain? 

    I suspect it’s likely that it will take more analysis than blind faith of a repeat reaction to Fed stimulus to determine market direction for the longer-term.

    Other Voices:

    Bloomberg Business Week: ‘How Did Stock Prices Get So High?’ “Markets are not always rational. But they are rarely bananas. But while a nearly unprecedented litany of depressing indicators should be devastating investor confidence, the S&P 500 is up 14% in 2012. Stocks have reached levels not seen since the fall of Lehman Brothers and Bear Stearns. “This is about the strangest market environment I’ve ever seen” says Donald Luskin, chief investment officer at Trend Macrolytics.” . . . . . But hedge funds and individual investors have missed much of the rally and may decide to join the party. The Bloomberg Hedge Fund Index has gained only 0.5% this year compared to the gain of the S&P 500. Money managers don’t want to finish the year lagging the market so badly.”

    George Magnus, Senior Advisor on the world economy at UBS: “We are limping into the second half of the year, and the IMF has downgraded its economic expectations of growth even further. I don’t think the downgrades for Europe and the U.S. were a big surprise, but I think the Asian and emerging markets downgrades raised a few eyebrows. A global recession in 2013 is going to be a close-run thing.”

    Financial Times: “Equity investors like to buy when corporate revenue growth is accelerating. Failing that, expanding margins are good. If that is too much to ask, they will accept low valuations. Right now they are settling for none of the above. Analysts are projecting earnings growth for the S&P 500 to decline in the 3rd quarter, the first negative reading in three years. And companies across the board have cut sales guidance going forward. . . . Despite analyst’s pessimism about the current quarter there is still plenty of room for further downgrades. Margins which hit an all-time peak last year, are falling but remain near the peak, leaving plenty of room to revert to historical means.

    Associated Press: “The creation of a European banking union is important to prevent any bank failures from torpedoing the finances of financially weak countries such as Spain or Italy. But a meeting among European finance ministers over the weekend underscored the lack of consensus on the details of such a union. “It appears markets will have to wait longer than expected to get clarity on Greece, Spain, and banking supervision. This continued delay could put downward pressure on risk assets,” said Stan Shamu of IG Markets in Australia.”

    Subscribers to Street Smart Report: The new issue of the newsletter will be out tomorrow, probably late in the day in the subscribers’ area of the Street Smart Report website.

    To read my weekend newspaper column click here: Enough With The Fed’s Transparency Already! September 14, 2012.

    Images: Flickr (licence attribution)

    About The Author

    Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!