February 3, 2012

Market Outlook

Chloe Lutts

Correction, Then On To New Highs

Aside from a few pessimists and perma-bears, most of our expert contributors are now expecting the market to finally challenge its pre-crash highs in the first half of 2012. However, most are calling for a near-term correction first. Below, Capital Growth Letter’s John Bollinger, Wyatt Investment Research’s Jason Cimpl and The Stock Trader’s Almanac’s Christopher Mistal make their cases.

“We have come a long way and a lot of people are talking about the stock market being overbought and vulnerable. Several famous market pundits who are ‘always right’ are calling for a top here and the usual chorus of bears is growling loudly. Yet, when looked at objectively, the market is in relatively good shape. … An oft-overlooked aspect of price action is the breakout, stocks rising above prior resistance levels. We have several ways of looking at these, from stocks closing above their upper Bollinger Bands to groups making 13-week new highs. The bottom line here is that there are a lot of stocks on the march, which is exactly what we expect to see if the market is to continue higher. In fact, one of the hallmarks of a top is an advance lacking breakouts. With so many stocks on the march the natural question is: ‘Are we overbought?’ Our friend Fred Wynia, the same person that helped us get the Alphier indicators up and running, reports that less than 15% of stocks in his database are overbought, a reading of 140 or higher on the Expectations Index. So though many are claiming that this market is overbought, Fred’s democratic measure of stock price action does not agree.

“Leadership: Coming out of the lows we saw value stocks assume the leadership role and now we are seeing a gradual shift towards growth stocks, which is exactly what we’d expect to see as valuations start to increase and greater levels of projected growth are needed to justify owning stocks. If the growth phase roughly equals the value phase, that would mean another 10% to 15% for the averages by mid-year. … Market internals: This is perhaps the brightest spot. The Advance-Decline line is out to new highs. New lows are non-existent and new highs are expanding nicely without reaching unsustainable levels. Group and sector participation is good as well, with quite a bit of healthy rotation going on. Various breadth indicators are at or near overbought levels, which does point up the chances of a correction, but they are mostly not at the extreme levels that would demand defensive action. (The Power Index is at warning levels.) … The bottom line here is that on balance the outlook is good for stocks, perhaps into mid-year, but we should expect increasing volatility and acknowledge the possibility of a correction.”

John Bollinger, Capital Growth Letter, February 10, 2012

“The eight-week rally rolls on and I still remain a skeptic. Maybe not quite as skeptical as New York Knicks fans are of Jeremy Lin, but it’s very close. Again, I don’t want to appear gloomy or perma-bearish. I am far from either about the stock market. I am very much bullish and I think nearly every major U.S. index will challenge its 2007 highs this year. But in the near term (one to seven days), the bulls need to concede some ground and recoup. Buyers have pulled the market higher since November without pause. While that may seem exceedingly bullish behavior, the price movement was not accompanied by volume. … The absence of volume concerns me because if the economy or Europe goes sour, the recent gains in the indices will all be washed away, much like they were in August. I want to see the market consolidate in order to tell where investors will be willing to provide them with support. Until the market pulls back (meaningfully), it is futile to assume where the indices could find support. With that in mind, it makes trading extremely risky in the near-term. While I think we should get a 3-4% pullback, if the indices motor higher from here without pause, a much nastier decline would be in the making.”

Jason Cimpl, TradeMaster Daily Stock Alerts, February 13, 2012

“In yesterday’s blog post, The 17% Correction Or New Bull Market At Resistance, Mr. Hirsch pointed out how the market has stalled at resistance and could be prone to a brief pullback before finally finding the strength to cleanly break out to new recovery highs across the board later this spring. Technicals and sentiment are at eerily similar levels to this time in 2011 and even in 2010. Markets were near resistance then and sentiment was excessively bullish. In both of those years, the market suffered a pullback (black arrows) before charging on to new recovery highs in April (green arrows).

“Will the market repeat this performance in 2012? At this junction, historical seasonality suggests that it is quite likely. Continuing labor market improvement (albeit painfully slow) indicated by respectable job gains in January and today’s initial weekly claims report, Europe’s debt crisis being contained (for the time being) and the Fed promising zero interest rates through 2014 also support further market gains. However, developed market debt and deficits, Middle East tensions and a presidential election still hang over the market and limit those gains. Barring some truly disastrous event, a brief pullback from resistance followed by a rally to new recovery highs later this spring does appear to be the path of least resistance for the market at this time.”

Christopher Mistal, Stock Trader’s Almanac, February 9, 2012