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Stock Rally Faces Important Test

Earnings Help Revive Equity Interest

The market has been looking for some good news. While IBM had a big miss Monday, the overall picture for earnings has been encouraging. From Bloomberg:

Profit for S&P 500 companies probably rose 5.9 percent in the third quarter -- a forecast that's been revised upward from an increase of 4.8 percent as of Oct. 10 -- and sales increased 4 percent, according to analysts' projections compiled by Bloomberg.

Rally Still Has Work To Do

This week's stock market video examines the question:

Is the current rally in stocks sustainable or will stocks eventually make a lower low?

Europe Still A Drag

While stocks popped Monday in the United States, the news continued to be troubling across the pond. In the first session of the week, the German DAX dropped 1.50% and the Stoxx 50 Index shed 1.18%. European stocks are highly correlated to the S&P 500, which is why U.S. investors would prefer to see some stability in that region of the globe. From Bloomberg:

"This correction might be the symptom for something larger," Benedict Goette, founder of asset-management firm Compass Capital AG in Zurich, said in an interview. "I do not expect a big positive impulse from the current earnings season in Europe. Unless a multi-day upmove develops, people will remain nervous. We're now in the highly volatile phase of attempting to bottom, but I would expect a final bottom only by the end of October or mid-November."

Investment Implications - The Weight Of The Evidence

If the concept of a countertrend rally is new to you, this video clip provides two specific examples from 2010. On our investment timeframe (longer), it is important to see evidence of a sustainable turn in stocks, rather than hope the rally will continue. As the market was finding at least a temporary bottom on October 15, we hypothesized stocks might hold at the lower support line in the chart below.

$SPX S&P 500 Large Cap Indx INDX

Possible Resistance Ahead

If the market continues to "care about" the blue lines in the chart above, then a good bull/bear test may be coming near points A, B, and C (or between 1920 and 1960ish). Other levels that can be used as guideposts are the Fibonacci retracements near 1920 and 1943. As of Monday's close, our current mix of stocks (SPY), bonds (TLT) and cash remained in line with the market's risk reward profile. Should the rally push the S&P 500 above 1943, the improvement would most likely allow for an increase in our equity exposure. The market will guide us if we are willing to listen.


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