So here we are—stuck in an environment of uncertainty regarding the debt crisis in Europe and declining expectations at home. The S&P 500 Index is back up to 1,200 and seemingly, those trading the index are benefitting from all the volatility. Index options traders must be relishing the current trading action in stocks and no doubt this choppiness is here to stay.

One thing I’ve noticed is that a lot of higher-dividend-paying stocks have been outperforming the rest of the stock market and holding up very well all things considered. It’s pretty clear that institutional (and individual) investors are craving dividend yield in a market with little expectation of capital gains. In fact, this market is more about preservation of capital, and dividends are the only way to earn a return on investment that beats the rate of inflation. Treasuries and cash certainly don’t pay anything and corporate bonds are still being shunned.

This is a market where investors don’t need to be in a rush to do anything. The stock market just experienced some very negative trading action—but it climbed back up to return to what I think is its equilibrium, which is 1,200 on the S&P. It’s actually quite impressive as far as I’m concerned, and I reiterate my view that the stock market would be quite a bit higher if sovereign debt and the prospect of a default in Greece weren’t issues. The fact that share prices clawed higher as the Street continued to reduce earnings expectations for the fourth quarter and first quarter next year is quite an accomplishment.

This is a stock market that wants to go higher and investors are waiting on the sidelines for a catalyst to jump in. If we could get more certainty in the global marketplace with the sovereign debt problems in Europe, I think we’d get a 10% jump in the main stock market averages, finishing off the year with a nice little rally. A lot of the earnings I’ve seen so far have been solid and, while corporations can’t keep up this performance forever without decent revenue growth, most corporate visibility I’ve read recently is saying that business is getting better.

The S&P 500 Index has been bouncing around, trading range-bound since August, and it’s almost entirely due to the situation with sovereign debt. Trading volume has been consistent, as the Index found support at 1,100 and resistance at 1,220. This trading action is symbolic of a general stock market correction and is very similar to the correction experienced from April to September last year.

If there is more progress in Europe, then the probability of a stock market rally improves significantly, especially before year-end. I hate to say it, but certainty in global capital markets is now up to the politicians in Europe. Let’s hope they get it right. The marketplace is getting very tired of this issue.

During the Federal Reserve’s Open Market Committee meeting on September 21, the Fed pulled yet another rabbit out of its hat of monetary tricks. From what increasingly appears to be an empty hat, Fed Chairman Ben Bernanke pulled out a $400-billion plan to buy long-term treasuries while selling short-term bills and notes held by the Fed. The expected net result will be to narrow the yield spreads between long and short maturities of U.S. treasuries.

The plan, quickly dubbed by commentators as the “Twist,” will further flatten the yield curve; something the market itself has already started doing in recent months. The historical correlation of the slope of the yield curve to the stock market shows that flat yield curves have been bearish for stocks, while steep curves have been bullish for stocks.

To put it another way, the larger the difference between yields on long-term and short-term maturities of T-bills, the better the long-term outlook for the stock market, and vice versa.

The 30-year chart of the yield difference between 10-year and two-year U.S. treasuries demonstrates the above historical correlation. Regrettably, in the brave new world of perpetual zero interest rates on short-term treasuries and record-low yields on long-term treasury maturities, numerous time-tested fundamental and monetary indicators have lost some of their accuracy and relevance.

The Fed’s September 21 announcement (about buying long-term treasuries to bring down long-term interest rates) has completely failed to perk up the moribund stock market, already dazed from the long-running Greek tragicomedy, the global economic slowdown, a dysfunctional Washington, and the usual flood of economic data and expert opinions.

Lacking the necessary smarts to make much sense from this information overload, I need to rely on technical and sentiment data to come up with “educated market guesses.” My last guess—that the S&P 500 would mimic the downside breakout of a head-and-shoulders formation on the chart of 10-year treasury yield—has turned out to be on the money.

The breakout quickly brought the S&P 500 to the downside target of 1,140-1,150. Over the subsequent eight weeks the S&P 500 has traded within 10% of the range just noted. Now the big question, the million-dollar question, is: what will be the resolution of this narrow trading range?

A textbook resolution to the trading range, the first scenario, would see the S&P 500 rally towards the neckline of its H&S top to a level of 1,230. Nine percent above where the popular stock market index sits today,

But considering its slope, any textbook rebound should run out of steam in the 1,260-1,270 range, and be followed by a re-testing of the August 2011 low of 1,101. My guess is that the test will fail and the S&P 500 decline will meet the 20% rule-of-thumb definition of a bear market. This is something indices such as the Dow Jones Transports, the Russell 2000, the NYSE and Canadian TSX Composites have already met.

New 2011 lows by the S&P 500 would confirm the new lows already hit by the NYSE Common Stock AD Line and the NYSE Upside/Downside Line. To put a positive spin on such bearish musings, on numerous past occasions (i.e. 1987, 1990, 1998, 2002) the market bottomed out during the month of October.

My conclusion: October will not be a pleasant month for the stock market this year. But it could also mark a new temporary bottom for stocks prices, from which they will likely bounce.

I view the stock market’s recent trading action as impressive. The S&P 500 Index has clawed its way back up to the 1,200 level, which is technically significant. Just last year, the index (and others) broke down after a strong run and then recovered meaningfully. While the past can’t predict the future, there is a strong similarity in the share price action.

I think that the broader stock market is reasonably priced and that corporate earnings will be strong enough to be the catalyst for a solid upward move in stocks. How long a little rally might last is unpredictable in this kind of environment. Investment risk for equities is high and the sovereign debt issue hasn’t gone away. I’m certain this issue in Europe will once again be a focal point for investors in the not-too-distant future.

Also impressive is the spot price of oil, which is climbing its way back to the $90.00-a-barrel mark. Silver and copper are ticking higher again and this is a positive signal about confidence in the global economy. And we can’t ignore the spot price of gold, which is persistent in its strength. While there are still a lot of stocks that are down, the commodity price cycle seems to be alive and well.

Without any new shocks to the system, I expect share prices to trade slightly higher from current levels in anticipation of third-quarter earnings season. Like we’ve seen all year, there haven’t been many companies revising their previous guidance lower. The general view that I got out of the second-quarter earnings season is that most corporations are expecting solid earnings in the bottom half of the year. With share price valuations reasonable, this is why I expect a stock market rally based on good earnings news. And, while it’s too early yet, I think the expectation for solid earnings will help the S&P 500 Index climb back above its 200-day moving average.

Here at Lombardi Financial, we continue to talk a lot about our positive expectations for precious metals and gold stocks in particular. This sector remains one of the most attractive for equity market speculators. There have been several mid-tier acquisition announcements in the gold mining industry recently and this consolidation trend is just getting started. Takeovers and mergers are going to flourish in this industry over the coming quarters, because share prices are high and so are bank accounts. It’s a great time to be a speculator in this specific market sector, because the fundamentals are so strong. You have a strong underlying spot price for gold, with the market’s expectation for $2,000 an ounce this year. Gold mining companies are flush with cash from their previous record financial results. And now companies want to bulk up on production, because it’s cheaper to buy another established producer than to go exploring on new properties.

What are the best stocks in this market? For speculators, they are gold stocks. For long-term investors, they are higher-dividend-paying securities.

I think it’s probable that the stock market will continue to convulse for the rest of the third quarter and into the fourth. The trend in economic news is down and so is investor sentiment. We still have a lot of problems with sovereign debt issues in Europe and this is an investment risk that isn’t going away anytime soon.

Right now, investor expectations are being dramatically reduced. The marketplace now expects little to no growth in gross domestic product (GDP) and investors aren’t expecting much, if anything, from the stock market. I still expect both the third and fourth quarters to be very good in terms of corporate earnings, so my view is that the stock market will undertake a prolonged period of consolidation around current levels, with chances of rallying in the fourth quarter.

The old adage that investors should “sell in May and go away” perfectly illustrates a fitting strategy this year. If you pull up a chart on the S&P 500 Index, you’ll see the market’s substantial price appreciation from last September. Then in May, the market began to consolidate; slowly deteriorating until its recent move, breaking both its 50-day and 200-day moving averages.

The S&P 500 Index has actually been in a period of consolidation for the last 11 years. Pull up a long-term chart on the Index and you can see it plainly. What you will also notice is the current price action, which looks like a right shoulder formation from the head set in 2007. It’s an ominous-looking pattern and, when looking at it, you can’t escape the feeling that the trend is going to complete itself. If it does, it means the stock market could be in for a lot more pain. Over the last decade, 800 on the S&P 500 stands out as the bottom support point. Regardless, the buy-and-hold investment strategy has barely paid off over the last decade. Without dividends, investment returns would now be negative, as the S&P 500 is currently trading below its level in December of 2008.

Clearly, the best stock market advice would have been to buy technology stocks and Internet stocks in the 1990s. Then, the best subsequent investment strategy would have been to cash out of the stock market and buy real estate for most of the next decade. Now, it would seem, precious metals and agricultural commodities are experiencing the best price action from the global business cycle. First it was stocks, then it was real estate. Now the future belongs to commodities.

I think the commodity price cycle will keep running for a number of years and, in a period of slow economic growth, investors need to have significant exposure to this sector. The fundamentals haven’t favored stocks for quite a long time. The real estate cycle was strong and highly profitable for those who got in and out at the right times. Now, all the debt in the world and money supply growth is creating a sustained period of higher inflation. Going forward, commodities and those assets that benefit from higher inflation will be the winners.