What the Current Sideways Trading Could Mean

by George Leong, B. Comm.

Markets have been drifting in the past week, as there is some hesitancy, plus the fact that stocks are technically overbought given the rally. The current positive bias is largely based on a belief that the recession will be coming to an end perhaps in early to mid-2010. The evidence so far has been some encouraging signs in the housing market, a key factor that will drive spending and the economy going forward. The housing market is showing some improvement and we may be at a bottom, albeit it will still take some time for a sustained recovery.

In addition, the major global economies are showing some signs of reversal. China is growing at around seven percent to eight percent and this will help the demand for commodities, as we have been seeing with the upward move in the CRB Index of 22 commodities. In the U.S., we saw a better-than-expected second-quarter GDP that suggested the U.S. economy was beginning to pull out of recession, as the smaller-than-expected decline in the second quarter was a vast improvement over the 5.5% drop in the first quarter. Overseas, Europe is continuing to be slow, but there have been some indications that the worst may be over.

In the United States, while the economy is showing some positive signs, there continue to be issues with the jobs area. The jobs market remains at risk and we could see the country’s unemployment rate hit 10%. The reality is that the fear of losing a job and watching home values decline will continue to rattle consumers. The recent weak consumer confidence report supports the risk towards consumer spending.

Markets are showing some sideways trading. In my view, there two ways of looking at the current market action. We appear to be seeing a pause in the market before stocks eventually trend higher. Alternatively, stocks may fail to move higher and reverse to the downside. Markets have been losing some steam over the last two days, but there so far has not been a major downside move following this rally.

The key is to watch your positions and take some profits on some of your big winners. It has been a nice ride, so you want to protect the gains.

We continue to see an uptrend in the overall market. As of August 6, about 88% of all U.S. stocks are above the 200-day moving average, up slightly from 87% a week earlier and 67% a month ago. The same goes for the shorter-term moving averages.

Oil continues to hold above $70.00 a barrel, but is stalling. Commodities are moving higher on economic optimism.

I continue to positive at this point, but also anticipate some profit-taking given the extreme overbought condition.

The second-quarter earnings and guidance have been largely good, yet there are questions regarding the reduced estimates that many companies previously provided, so meeting or beating Wall Street EPS estimates has not been that difficult. There may be a question of earnings quality that could spoil the fun. What we see in the third and fourth quarters will be critical and will need to be good for markets to advance.