S&P 500 Breaks Two Important
Moving Averages, But Stocks Are
Cheap & a Rally’s Near

It's surprising that the stock market reacted so strongly to news of weaker gross domestic product (GDP) growth and consumer spending numbers. It seemed fairly obvious that this was going to happen and the recent trading action in stocks suggests that institutional traders were just waiting for a catalyst to sell.I find it surprising that the stock market reacted so strongly to news of weaker gross domestic product (GDP) growth and consumer spending numbers. It seemed fairly obvious that this was going to happen and the recent trading action in stocks suggests to me that institutional traders were just waiting for a catalyst to sell. They know that corporate earnings are decent, but with the S&P 500 Index right at the point of breaking its 50- and 200-day moving averages, the selling was pronounced.

So, with the main large-cap index having crossed these two important moving averages for the second time in two years, the stock market could actually go either way. But, this market isn’t expensive and that’s helpful. I see share prices just as easily consolidating between 1,200 and 1,100 on the S&P; even in the face of poor economic data. I don’t expect a total market breakdown, because there’s likely to be more stimulus from the Fed over the coming months (due to the stalled economy), interest rates remains very low, corporate earnings are good to very good, and there’s no other vehicle for institutional investors to generate a rate of return that beats the rate of inflation (this pertains to dividends). As I wrote previously, the current trading action in stocks looks very similar to what transpired between April and October last year.

Of course, stock picking right now is difficult. Now is the time to be considering new investments in large-cap, blue-chip companies that pay solid dividends. Now isn’t the greatest time to be a speculator, with the exception of gold shares.

As odd as this may sound, if you look at the charts and consider what news hit the wires and how the market reacted, I have to say that the stock market has been incredibly resilient since it bounced back from the March low of 2009. Big companies have been extremely good at managing their businesses in this slow growth environment and the fact that most have been able to grow their earnings is a real accomplishment.

It’s my feeling that large-cap earnings growth will fuel a stock market rally sometime in the fourth quarter and that the S&P 500 Index will be able to finish the calendar year with a low double-digit gain. According to Bloomberg, the Index is currently trading at 13.2 times earnings, which is 20% below the average valuation of the S&P since 1954.

If you were to sell the market right now, it would be a loud bet that the U.S. economy is going back into recession. Frankly, I don’t see this happening given all the current information. I’m not predicting that growth is going to be robust, but the economy is still trying to balance itself out after all its excesses and the numbers are going to be messy for a while longer.

The stock market is likely to be choppy and reactionary over the very near term. My economic analysis suggests that this is part of a bottoming process, setting the stage for a new stock market rally.