Near-Term Outlook: Markets May Have Some Further Upside

 |  Includes: DIA, QQQ, SPY
by: Disruptive Investor
The S&P 500 gained 5% for the week ended August 26, 2011, after four weeks of losses in the indices. The bounce back in the markets can be attributed to two major factors – oversold conditions prevailing at the beginning of the week and Mr. Bernanke’s speech at the end of the week.
The key question for short to medium-term investors at this point in time would be: Are we headed higher or might we again see resumption of downside in the markets in the coming weeks?
This article discusses the probable outlook for the market for the remainder of 2011.
In my personal opinion, we are likely to see some more upside in the equity markets in the very near-term, before any further downside.
Mr. Bernanke’s Friday speech might ignite a rally in the markets primarily due to the following two reasons:
1) The Fed is not ultra bearish on the economic outlook. Had that been the case, we would have seen immediate stimulus measures.
2) Mr. Bernanke also assured the markets that the Fed has more tools and is committed act in case of any meaningful slowdown.
3) Mr. Bernanke’s assurance that the long-term fundamentals of the economy are intact.
I have to admit that concerns remain in the Euro zone related to banks and sovereign debt. However, sentiments in the European markets also look ultra bearish and a rally in the near-term can’t be ruled out.
At the same time, Asian markets have also witnessed significant correction in the near-term and look oversold in the short-term.
Therefore, in all probability, we are headed higher in the foreseeable future.
The next obvious question would be – how much higher?
In my personal opinion, the markets might see another 5-10% upside from these levels. As evident in the chart below, the critical point to watch out for would be the 200-day EMA on the S&P, which is currently at 1258. This level might act as a key resistance zone on the upside.

Click to enlarge

Further, from a fundamental perspective, economic news inflow might not be pleasant enough to help the index breakthrough that key resistance level.
Therefore, in my personal expectation, the markets will again be headed lower after some intermediate rally.
On the downside, the July 2010 lows on the S&P of 1,022 might be the levels where market finds support. I am not suggesting that we are surely headed towards those levels in the next 2-3 months. In my opinion, the second bout of downside in the markets will trigger some action from the policymakers. However, that will come only after a meaningful downside in equity markets and flow of money into treasury bonds, which would lower the yields.
There is also no doubt that the economy is on a slow growth path. What the policymakers are waiting to see, before taking any action is if we headed for muted growth or a very meaningful slowdown and recession.
In my opinion, the economy might surprise on the downside. I had discussed some indicators, which make me for this opinion in another article.
Therefore, from an investment perspective, traders can benefit from the expected volatility in the coming 2-3 months. For long-term investors, a wait and watch approach might help. Also, for investors looking to have some positions in the market, defensive sectors like pharmaceuticals, healthcare and fast moving consumer goods would help preserve capital more than sectors such as commodities. However, any meaningful downside in markets (another 10-15%) can be surely used to consider fresh exposure to equities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.