What's changed? The broad market indexes have gained more than 4% thus far in the month of January. When you look at the entire 12 months of 2011 the S&P 500 index returned zero percent, you have to believe that something has changed, right? We could say the leadership is a sign of change. The homebuilders, semiconductors, transportation and financials are the right sectors to reflect a changing economic picture.
The one that is the most telling is homebuilders. While we cannot say the housing sector is improving overall, we can note that the builders are finding a way to make money and sell new homes. Indirectly, they have redefined the housing market. Time will tell what the condition is of the entire sector. Bottom line, these sectors are sending a positive message about the state of the continued recovery.
After all the worry and news related to the European Union and Sovereign Debt there seems to be hint of optimism showing in the sentiment data. The negative outlook hit levels not seen in many years last summer. In October the markets turned off their lows in hopes of a bailout or backstop to be created by the European Union and the European Central Bank.
The details of that "backstop" or bailout fund are still being hammered out. Most don't expect all the details in place until July. Regardless of the extended time lines the overall market sentiment is focused on economic data improving in the US, in addition to a better jobs picture over the last four months. The old adage that no news is good news comes to mind. The news from Europe has been very quiet over the last seven weeks.
Have investors gotten too optimistic too quickly? The technical indicators are showing an overbought market short term. The AAII polls are at high levels of optimism. The investment advisor survey show 51.1% bullish which is near the top and indicating too much optimism relative to stocks. The bears were down to 29.8%, showing a lack of concern near term towards the downside of the market. These are all just indicators that show historical ranges negative or positive, but they are a good barometer for knowing when to protect against the downside risk or look for upside opportunities as they reach extreme levels. They aren't exactly extreme, but they are sounding a warning signal short term. Any time the market moves up 4.5% in one month you have to protect against the short term reversal.
Looking at a chart below of the S&P 500 index you can see the move off the October low. It was followed by a big test in November and second test in December and has been successful at moving higher at each stage of the trend. Thus, the short term trend off the October low remains in play. The multiple resistance points have one-by-one given way to the advance of the market churning higher. We aren't out of the woods yet, as the index now faces the intermediate downtrend line (white) near the 1320 level.
There are plenty of other resistance market up to last years high at 1363. Thus, the upside will be a challenge each step of the way. At some point the move from 1205 to 1316 will be challenged. How much and how long is the looming question. One thing we know for certain, the more speculation of a correction/pullback the more likely it will become a self fulfilling process.
click to enlarge
The key is to determine what you believe to be true. For example, I think the S&P 500 index will progress towards the 1363 mark in the coming weeks. If it doesn't, a test of the 1295 mark first, and then 1265 second will be key support levels. If they hold, I am willing to add to my positions and look for the next leg higher to eclipse the previous high and continue the upward trend. If the key support levels fail to hold, I will set my stops at 1255 to protect my downside risk exposure.
This is called my belief or what I expect to happen. It is also called speculation. No matter how much I believe this to be true looking forward, the market must validate the belief by fulfilling my outlook. Each step of the way I have to adjust my risk levels or escape points based on what the market does. This is managing my belief in conjunction with the reality of the market.
Whatever happens moving forward, the first three weeks of the year have been exciting. Stay focused on your goals and manage your risk each step of the way.