Is the Risk Rally Still On?

by: Abigail Doolittle

The big question on everyone's mind is whether the risk rally of late August through early November is still on despite the recent swoon in equities, precious metals, and commodities.

I contend that the rally is on still and may have strong legs ahead of it and especially as it pertains to the S&P 500.

While much of my opinion is related to technical analysis, I believe that the fundamental backdrop may support the technical aspects as well.

First and turning to those technical aspects, the S&P 500 is well into the confirmed Inverse Head and Shoulders pattern that I’ve mentioned before. This pattern’s target is 1,250.

In addition and more recently, it seems the index may be in the middle stages of a Symmetrical Triangle and its target would be about 1,250 as well and thus these two patterns would be mutually supportive. More importantly, however, such a fulfillment would set the S&P 500 up for a much more significant move up. It is for this reason, in part, that I believe the S&P 500 will reach 1,300 in the next 3 to 6 months.

This being said, there are some bearish pattern possibilities that are also at play right now and more about all of these patterns can be found here with much charting detail provided.

Second and taking a look at the fundamentals, there is reason to believe that the real world backdrop may be improving and thus supporting the potential positive technical aspects that I’ve mentioned.

First, the employment situation seems to be finding some footing with the most recent weekly jobless claims coming in close to the psychologically important 400K level with claims at 407K while this was the fourth consecutive week with initial claims below 450K. In addition, the reports out on both October and September pointed to the possibility of stabilization with more jobs added to the labor force than expected. Specific to October, 151K jobs were added relative to consensus of 60K.

Second, M2 has been on the rise for 18 of the last 19 weeks while bank lending is up 1% from this time last year. Although painfully simplistic, improvement in both and in the velocity of money is crucial for an economy that runs on money and credit.

Third, retail sales have been up for four out of the last five months while October was particularly strong with retail sales up 1.2% relative to expectations of 0.7% suggesting that perhaps consumers are beginning to spend a bit more again. In addition, holiday retail sales are expected to be decent with the National Retail Federation forecasting sales to be up about 2.3% this holiday season in comparison to last year’s 0.5% gain and the 4% decline made in 2008 holiday sales.

Lastly--and this falls between the technical and the fundamental--is the dollar. This entire move up by the S&P 500 and the other equity indices, the precious metals, and the commodities has been driven by the weak dollar through the weak dollar trade that I wrote about in September.

While the dollar has gained nearly 6% since November 4 against a basket of other currencies, the dollar index is caught in a confirmed negative reversal pattern for now and this suggests we may see a resumption of the broader decline that began in June. More about the dollar index’s technical aspects can be read here as well.

The fundamental reason for thinking the dollar is likely to resume the decline that began in the beginning of June is held in relief around sovereign debt fears. Specifically, if investors begin to take comfort in the financial aid that Ireland is to receive along with the possibility of the European Financial Stability Facility doubling in the amount it can lend, solvency fears that have re-plagued the euro-zone in recent weeks may be contained. This would likely have the effect of strengthening the euro to the dollar.

If the euro should strengthen due to relief around euro-zone debt fears and push the dollar down, such a dynamic may be the very thing to re-engage the risk rally in equities, precious metals, and commodities.

What would certainly help such a re-engagement and particularly with regard to the S&P 500 is a defined extension of the Bush-era tax cuts for all income brackets. It is this possible extension that could be the fundamental “game changer” that would tell us that the risk rally is still on.

Disclosure: Long: BGU, FAS, SAA