Stocks May Get One More European Scare

Includes: SPY
by: Chris Ciovacco

European timelines leave the door open to ongoing stock market volatility within the context of a bullish trend. Stocks have reacted positively to significant European progress, but firm debt crisis decisions may not come for another six weeks due to the following:

  1. Spain must request formal assistance before any new bond buying program can begin.
  2. The European Central Bank (ECB) is requiring the eurozone's permanent bailout fund, the European Stability Mechanism (ESM), to be in place prior to taking additional action.
  3. The ESM has been challenged in the German court system with an expected approval not coming until September 12.

Since financial markets are always looking forward, stocks are handicapping mechanisms providing insight as to the odds of hurdles 1 through 3 being crossed above. Said another way, the markets can help us answer the question, "Will Europe get their act together?" The current answer from the markets appears to be "yes".

When traders study charts, they know a healthy market tends to remain above both the 50-day and 200-day moving averages. If the slopes of the 50-day and 200-day are positive, it is indicative of a rising trend. As shown in the table below, the answer to all four questions for the S&P 500 is "yes".

In a May 25 video, we noted numerous technical signals that told us to be open to a rally attempt in risk assets. The chart below shows the S&P 500's 50-day moving average in blue and 200-day moving average in red. The rally attempt off the June lows has successfully morphed into an uptrend.

The markets know that full-blown, Greece-like bailouts for Spain and Italy would overwhelm the European bailout fund. A "full" bailout implies a country can no longer access capital in the open market (sell bonds). Reuters describes the attempted workaround crafted by the ECB:

The aim of the plan taking shape is to keep Spain and Italy in the capital markets at an affordable cost both to them and to eurozone governments, whose rescue funds are too small to cover Spain's full funding needs for three years, let alone Italy's.

The August 4 video below highlights a bullish bias in numerous markets, including the S&P 500, Dow, and EAFE Index (foreign stocks). After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video: Bulls Want Press Started

A basic tenet of chart analysis is that a trendline that previously acted as resistance for prices (see blue arrow below) may provide support (pink arrow) once it has been broken. The present day S&P 500 (shown below) has followed the trendline break script thus far, providing additional support for the bullish case.

As long as Europe inches forward on debt crisis solutions and the trend in stocks is up, we will continue to give the bulls the benefit of the doubt.

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