Economic Analysis: Upward Moves Positive, But Resistance Will Be Difficult

The stock market is riding a four-week wave up, but it’s premature to call this the start of a bull market after just escaping the bear market. The stock market is riding a four-week wave up, but it’s premature to call this the start of a bull market after just escaping the bear market.

The stock market and economy continue to show encouraging signs, but there remain issues in jobs, manufacturing, and housing. The debt crisis in Europe is ongoing and not yet resolved, but a final agreement is expected, as ministers meet at the European Union (EU) Summit. Nonetheless, the situation in Europe continues to be a financial and political mess and this will impact the stock market.

Earnings so far have been good, but not spectacular, especially the guidance. Reading through the reports, companies still appear to be nervous about the debt crisis in Europe and its negative impact on U.S. growth and, ultimately, the stock market.

For the third quarter, estimates call for blended earnings to rise 14.8% as of October 24, up from 13.1% as of October 3, according to Thomson Reuters. Of the 142 S&P 500 companies that have reported, 68% exceeded estimates, with 18% falling short. These early results are somewhat off from the second quarter, in which 71% of S&P 500 companies in the stock market beat estimates and 19% fell short. This may or may not indicate a weaker third quarter, but we need to see leadership from technology and financials in order to drive the stock market higher.

The bear market has dissipated for the time being, with the key stock indices closing higher in four straight weeks to October 21 and aiming for a fifth week. The buying has been impressive given that the S&P 500 fell to a new 52-week low of 1,074.77 on October 4 and, in a bear market, down 21%. The chart of the S&P 500 shows a base at around 1,100 and a subsequent breakout at 1,200. But, as has been the case, a break at the 200-day moving average (MA) of 1,274 would be positive and drive the index to 1,300 to 1.350, representing the previous top.

The DOW is back positive this year, up nearly three percent as of October 24. Again, there is a base and a breakout. Watch for a move to the 200-day MA at 11,967.

The NASDAQ advanced into positive territory for this year on October 24; but, more importantly, broke back above its 200-day MA of 2,692.

Small-caps have escaped their bear market, with the Russell 2000 narrowing its decline to 15%.

The near-term technical view for the stock market is bullish, with the key stock indices holding above their respective 50-day MAs and above or edging higher towards their respective 200-day MAs, but facing an overbought condition. The Relative Strength has increased.

Investor sentiment on the NYSE stock market has been encouraging, with bullish readings in eight of the last 11 sessions to October 24. The NASDAQ is not as strong.

So, while optimism appears to be back, you need to be careful, as the stock market can move quickly to the downside.

I continue to favor small-caps. Read my recent comments in Small-caps in a Bear Market, But Have a Long-term View.

At the same time, you need to continue to use put options as a hedge against a possible market reversal. Read How to Survive During This Economic Chaos.