Regardless of where you come down in that on-going debate, the market’s strength has confounded most, if not all, market watchers. For those who monitor happenings in the technical analysis world, December 23, 2009 was an important day. That was the day when the S&P 500 traded above 1121.44 which is a 50% upside retracement of the October 2007-March 2009 decline. Holding that level and then pressing higher was an almost-mortal wound to the few remaining bears in the market.

Fast-forward eleven months and factor in some very intense volatility and by November 5, 2010, the S&P 500 was at 1227.08; just below the 61.8% upside retracement of October 2007-March 2009 decline which is 1228.74.

You may be thinking…so what?

November just ended with the index posting a 0.23% loss for the month which makes November the fifth losing month of 2010 (albeit the smallest loser by far). Decembers over the past twenty years have been quite kind to investors in the S&P 500. Only four of the past twenty Decembers have posted losses and two of those losing Decembers posted losses of less than 1%. Seems like a proverbial no-brainer…play the odds, right?

Maybe not.

The market’s response to a break-out attempt up through 1228.74 should not be quickly dismissed. While history argues that December should be a winner, the recent negative response to the 1228 area has definitely caught the attention of the technical crowd and the much-battered bears.

It seems that path of least resistance now may be to the downside. Any retail sales data that suggests a less-than-robust Christmas shopping season could quickly set the stage for at least an attempt at a sustained downside move. 

We see short-term risk for the index down to the 1121-1134 area. The significance of 1121 was mentioned above and 1134 is the 200 Day Moving Average. How investors respond to a weak ending to November may tell a lot about true underlying conviction. 

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The moniker of Black Friday (which traditionally belongs to the day after Thanksgiving) was recently morphed and overlaid onto the entire month. If that is the case, Black Friday may draw far less activity in stores. Another potential side effect of a “Black November” instead of Black Friday is that retailers will run deeper discounts for longer periods of time. That is great news for shoppers but not so much for the seasonal earnings picture of retailers.

We’ll see how that plays out but it’s difficult to imagine a robust shopping season given the unemployment and underemployment data. 

Market action as of late has produced more volatility. In response to the mid-term elections and the Fed’s much-anticipated QE2 ($600 Billion promise), the S&P 500 rallied 3.68% from session low on November 3 to session high on November 5. The session high on November 5 was 1227.04; a new 2010 and recovery high. That peak was up 84.03% from the 2009 bear market low (March 6). Interestingly, 1228.74 is a 61.8% upside retracement of the October 2007-March 2009 decline. We suggested the importance of the 1228 area in a November 2 blog post titled, “Here We Go….”.

In April 2010, the index reached 1219.80; the peak of a ten-week, 16.78% rally and the beginning of a nine-week, 17.12% decline. So, which trend driver is stronger…profit-taking from the 1220-1228 area or more bullish bets on the Fed?

QE2 (and all things Fed) has been a primary catalyst for the recent leg up in the market. The November 3 session low was S&P 500 1183.56. Yesterday’s close was the lowest close since November 3. 

IF the year-end window dressers are coming to work early this year like the Starbucks red cups, 1183.56 may attract at least an attempt at support. Given the pre-market indications this morning, there may be a test if that level during today’s session. 

How investors respond to a test of the 1183 area will be an important indicator as to the likely direction for the remainder of 2010.

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The day after the md-terms, Ben Bernanke and friends finished a two-day FOMC (Federal Open Market Committee or Fed) meeting and rolled out a $600 Billion plan for more quantitative easing (QE2). Investors liked that because it assured markets around the world of our government’s resolve to “print” as much money as it takes to support, backstop, guarantee, stimulate, attract (pick a verb) buying or at the very least…discourage broad market selling. 

Afterall, those who have fought the Fed since late 2008 (sold stocks), despite a few short-term wins, have been utterly squashed as every period of weakness from any point in the past two years has proven to be a buying opportunity.  

So is it the right thing….now…to simply close your eyes and pull the “buy” lever? With approximately seven weeks left in a surprisingly strong 2010, the path of least resistance certainly seems to be to the upside for the broad market.

But… 

Momentum is a tricky thing to evaluate. Look at names like GOOG, AAPL, CMG, PCLN, and NFLX. There are many other examples but these stocks illustrate optimism gone wild. Analyst estimates are now chasing the stock price to justify ever-higher levels. Consider that from the October-November 2008 lows to the October-November 2010 highs the stocks above have rallied as follows: GOOG +155%, AAPL +306%, CMG +530%, PCLN +848%, and NFLX +932%. During that same period of time, NAZ 100 rallied 116% and the S&P 500 rallied 84% (S&P 500’s low came in March 2009). Isn’t it strange how a two-year, 84% rally does not sound like all that much? 

Accounts who have sold and/or shorted any of the above names have been obliterated. So now sellers are terrified and all news is good news…..for now.

As we have quoted many times, Alan Shaw, a technical analyst with Smith Barney “back in the day”, defined bull cycles as having three distinct phases: disbelief, belief, and greed. Per Shaw, bear cycles also come in three phases: disbelief, belief, and fear. 

For the five names above and for an increasingly large portion of the market, we believe the bull cycle is firmly in the greed phase and the baton may be getting passed to a bear’s disbelief phase.

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Today we get the mid-term elections and there are voices on both extremes (non-politically speaking) who are calling for vastly different outcomes in terms of market response. The most pervasive and popular expectation supports an old stock market saying; “the trend is your friend”. Meaning that most expect the recovery rally to continue. That approach, regardless of one’s view of the rally’s catalyst, has been the right approach since March 2009.

It is quite doubtful if you polled most money managers back then when we were becoming familiar with a wave of acronyms to describe various government programs to “backstop” certain securities, companies or whole industries that those managers would have envisioned the magnitude of rally that we have seen over the past twenty months. Performance, low to high, for the major averages during that time has been as follows: Dow 30 +74%, S&P 500 +82.4%, Naz 100 +110.83%, Russell 2000 +117.74%. With numbers like that, a passing observation can quickly conclude that whatever the spark was for those rallies, it certainly worked.

However, the Dow 30 and S&P 500 are beginning to stall at key resistance levels. Dow 11,246 and S&P 1229 are 61.8% upside retracements of the 2007-2009 declines. Recall that all-time highs for those (and several other) indexes came on October 11, 2007. From that day, the indexes began what would become respective seventeen-month, 54.4% and 57.7% declines. 

As we have suggested on several occasions, traders are full of short but very descriptive quips about the market. In the 1923 classic, “Reminiscences of a Stock Operator”, a book presumably about the famed stock speculator Jesse Livermore, another one of those great quips is offered. 

The four worst enemies of the speculator are ignorance, fear, greed, and hope.

Over the past several weeks, a tremendous amount of HOPE has gripped the market with bets on the Fed’s ability to deliver on very lofty expectations for another massive dose of quantitative easing (QE2). With today’s elections likely to shift power in Washington and tomorrow’s FOMC meeting set to roll out their plan to continue supporting or stimulating the broad market, a fifth “enemy of the speculator” has to be considered….uncertainty.

We believe the market is increasingly setting itself up for a “buy the rumor and sell the news” phase in response to news flow this week. 

Regardless of where you land politically, get out and vote!!!!

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Apparently, none of that matters.

Yesterday, for the first time ever, the government issued paper with a negative yield. $10 Billion in five-year TIPS (Treasury Inflation Protected Securities) were sold yesterday with a yield of -0.55%. Why? Those investors are betting that the Fed will be wildly successful in introducing controlled inflation into the market and thereby stimulating the economy. Their risk? Stagflation or Deflation. If the Fed is unable to pump enough liquidity into the economy to prop up and sustain a recovery, those investors will actually pay 0.55% for the privilege of loaning their cash to the US Government.

Market response? Zero.

The G-20 Finance Ministers and Central Bank Governors met last weekend in Seoul and agreed to a “plan that would avoid dangerous currency devaluations and would also attempt to reduce trade imbalances.” That plan was reportedly introduced by the US but was met with strong opposition from Japan as well as other export-driven nations. The G-20 Business Meeting and Summit will be in Seoul during November 10-12. 

This Friday, we get the first of three estimates of Q3 GDP and economists are expecting +2%. Then, on November 2, the FOMC begins a two-day meeting. While no-one expects a move in interest rates (that used to be important), all the market cares about is the magnitude of quantitative easing that will be introduced or promised.

With as much anticipation as there is heading into next week (throw the mid-term elections in there just for fun), recent price action is saying that the results of GDP, FOMC, and the elections will be overwhelmingly positive. 

With the major averages near 2010 highs which are also recovery highs, the idea of “buy low and sell high” seems to have been replaced with “buy high and (hope to) sell higher”. Our view is that when momentum starts to look this one-sided, a sharp reversal can quickly develop.

We maintain our cautious view.    

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There has been much written and discussed in the court of public opinion as to the effectiveness of the past two years during which time the same political-leaning party has controlled the White House and both houses of congress. As we have said many times, one of the most time-honored stock market rules is “don’t fight the Fed”, which means when the Federal Open Market Committee (Mr. Bernanke and company) starts down the path of lowering interest rates and/or embarks on a set of policies intended to support the market, betting against that force is simply a bad idea. When the Fed can marshal the resources (money printing, bond buying, etc) of the entire United State government, it will get its way eventually.

So now what?

The market has enjoyed an unprecedented period of government guarantees and promises of more to come. So that brings us to a question. What happens if/when power shifts to a group of law-makers who wants to cut spending rather than spend freely?

Maybe the market is anticipating a power transfer and has been rallying in reponse to what MAY develop. However, it is possible (probable, we think), that a tightening up of the recent free-spending policies will be at least a short-term market negative.  

Separately, a Washington Post story today said that Fannie Mae and Freddie Mac could need as much as $215 Billion more in taxpayer bailout funds over the next three years. That came from the Federal Housing Finance Authority. The article reminds us of the progression of welfare to the mortgage giants. In 2008, President Bush pledged $200 Billion to keep the companies solvent. Then, as the situation escalated in a big, bad way, President Obama in early 2009 doubled that pledge to $400 billion. Finally, in late 2009, President Obama promised unlimited support to Fannie and Freddie. In addition to Fannie and Freddie, there has been $57 Billion in realized losses to the Deposit Insurance Fund of the FDIC as a result of failed banks since the beginning of 2009.   

The political barbs and promises are, as I write this, likely being loaded into media canons for rapid deployment during the final push into election day. Over the next several days, we will see some of the worst in people ascandidates simply hammer each other in hopes of swaying voters their way.

As for the investment landscape….if the recent bullish catalyst has in fact been the promise of more quantitative easing, a shift in political power could at least slow if not altogether stop the spending and guarantee spree. Such a development would likely give the bullish camp reason to slow if not outright reverse their collective sentiment.    

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Despite growing disagreements on the past and/or future effectiveness of aggressive government measures to stimulate lasting economic growth, the Fed’s comments definitely delivered just what the market wanted…..the promise of an open check book to keep artificially supporting the market that, the thinking goes, must attract real spending and investment at some point.

Interestingly, JPM and INTC earnings this morning were labeled as “superb” and “very strong”. Both stocks are now down on the day. Also, GPN (October 11 post-close) and ADTN (October 12 post close), reported strong earnings but sorely disappointed investors regarding forward guidance. 

As the market remains squarely focused on the next FOMC meeting (November 2-3) and is fully expecting a strong confirmation of current hope for more and aggressive quantitative easing (QE2, as some commentators are calling it), crowd psychology suggests that the bullish side of the boat is getting quite full.

At some point (we think sooner than later), investors will be forced to look out beyond a day or a week to consider implications of when the government stops functioning as buyer/guarantor of last resort. Investors are making an enormous bet that there will be no negative surprises in the foreseeable future from earnings or the economy or the geo-political stage or from just about anywhere else. 

It is often said in the depths of bear cycles, “Don’t bet on the end of the world…that only happens once.” It is equally dangerous to expect a perfect all-news-is-good-news scenario to last. The market has an uncanny way of surprising the largest group of like-minded investors. 

Just look at March 2000 and October 2007.

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The agency also released a wave of revisions for the twelve month period ending March 2010 which showed, not-surprisingly, that far more jobs were lost in that period than previously reported. 366,000 more overall jobs  (21.5% more) and 371,000 more private sector jobs were lost during that twelve month period than previously reported.

Fifteen minutes after the report hit the tape, Reuters put out an article in which many analysts are reportedly calling the likelihood of more (and big) Fed supportive/stimulative measures “almost certain” in wake of today’s Employment report.

So….does more bad Employment news assure that the Fed will keep pumping liquidity to “stimulate” the economy? Maybe not.

The S&P 500 rallied 82.9% during March 2009 to April 2010 based on a wide array of spending programs and  guarantees. The April 2010 rally peak of 1219.80 was just below a 50% upside retracement of the October 2007 to March 2009 decline (1228.74). Investors assigned a great deal of value to the 1200-1220 area in April 2010. The index first rallied back up through 1200 on April 14. Over the next fourteen trading days, the index spent three days entirely above 1200 and two days entirely below 1200. The other nine days were extremely volatile as the index vacillated above and below 1200. That brief consolidation was resolved to the downside and the index declined 17.1% from its April peak to July 1’s low of 1010.91.

Some voices within the Fed starting to squirm at the idea of keeping the printing presses in high gear. If those voices actually get traction and a larger following as mid-term elections draw near, the huge bullish catalyst of “don’t fight the Fed” could get shelved and then the market would actually have to stand (or fall) on its own merit.

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So, are the bears finally dead forever? Is it really different this time? Has selling officially become dumb?    

September, which is typically a weak month for the market, has been superb. With fifteen trading hours remaining in the month and quarter, the major averages have logged the following gains for September. Dow 30 +8.21%, S&P 500 +9.26%, Naz 100 +13.68%, and Ru 2000 +11.51%. Not only are those gains by far the best monthly gains in 2010, but they comprise the best broad market showing since April 2009. Individually, The Dow 30 is having its best month since July 2009 while the S&P 500 and Russell 2000 are having their best months since April 2009.

The NASDAQ 100 is on a whole different planet, technically speaking. The index is having its strongest monthly showing since October 2002 when it rallied 18.86%. Going back a bit further, in April 2001 the index rallied 17.92%. While it rallied an additional 11.6% by the May 2001 peak, the index abruptly reversed into a seventeen-month, 61.6% decline.

Since its bear market low in November 2008, the NAZ 100 has produced gains in fifteen months while producing losses in seven months. From THE low, the index rallied 102.1% over the next seventeen months while the industry philosophically debated the pros and cons of expansive government intervention and aggressive stimulus measures. 

Regardless of where you come down on the government intervention question, the market is a huge fan of it. One of the most widely-quipped market sayings is, “don’t fight the Fed”. Since January 2009, the Fed Funds rate has been at 0-0.25% and at the conclusion of each of the twenty FOMC meetings since January 2009, the market has primarily been concerned with language (Fed-speak) that promises or strongly implies that the Fed will keep pumping liquidity into the Financial system as long as necessary (or it is able to do so). The current key phrase looked for by the market in relation to how long the Fed’s programs will stay engaged is, “for an extended period”. As long as that phrase can be extracted out of the Fed’s statement, markets are happy.

Federal spending is sure to be a popular topic as mid-term election campaigns kick into overdrive. Any overtones that the government may slow or stop its on-going stimulative policies could set the stage for at least a challenge of the current bullish psychology that is firmly in control of the prevailing trend.

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Today’s Retail Sales report also showed that Retailers’ Inventories grew by +0.7% in July after growing by +1.1% in June. The bet seemed to be on a superb back-to-school selling season after retailers built up stockpiles. Today’s Retail Sales, on the surface, made a strong statement regarding consumers’ apparent willingness to keep on spending.

In a Bloomberg report, the following was said: ”Demand at stores like Kohl’s and Ross Stores climbed as more states had tax-free holidays and some merchants offered bigger discounts to lure back-to-school shoppers.”  

While it is normal for this time of year to see aggressive discounts, the massive inventory build seems to point to an extremely big bet on merchandise-hungry consumers.

As an aside, in the September 12 Washington Post, an article was written entitled, “Grim Expectations for Report on Poverty in the United States”. The articles lays out expectations for 2009 Census data on growth in numbers of people at or below the poverty line which is thought to now be 15%; the highest level since 1993.  That level is 13.6% higher than 2008’s level which would be the largest year-over-year increase on record. (Data began being tracked in 1959). That data implies one out of every seven people are at or below the poverty line.

The official report is expected later this week.

While implications of this data for the market are difficult to gauge, those data do seem to cast a bit of a cloud on the near term-prospects of Consumer Discretionary names. Further, if sales are being increasingly driven by tax-free holidays and discount programs, that could hurt EPS performance for retailers.  

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