The equity markets experienced one of the most volatile episodes in Wall Street history last week. Extended periods of low volatility, such as experienced the first seven months of the year, typically lead to investor complacency which is often found at a market top. Extremely high volatility is often found at a market bottom as investor fears reach an extreme.
Although it is premature to argue that a bottom is in place, last week’s performance had many of the elements found at an important market low. The market’s reversal to the upside late in the week was accompanied by an explosion in upside volume over downside volume. This argues that the powerful downside momentum that been plaguing the market for nearly two weeks has been neutralized.
From here it would be typical for stocks to move into a trading range that often includes a test of the lows near 1880 on the S&P 500. The upside short-term is expected to be limited to 2040. Looking further out to the fourth quarter, we anticipate that a number of factors could result in a positive outcome for stocks in 2015.
Improving economic conditions are likely to lead to stronger earnings, which would help relieve valuation concerns that have been problematic since the start of the year. This combined with the most oversold market in four years and a bullish seasonal tailwind that begins to stir in October, increases the potential that the long-term uptrend in the popular averages could be re-established later this year.
The technical picture has improved. Stocks are severely oversold with only 10% of NYSE issues trading above their 10- and 20-week moving averages. Investor psychology has moved from complacency to fear suggesting that liquidity is building on the sidelines. Weak market breadth that has plagued stocks since January reached an extreme at last week’s lows. This opens the possibility that positive divergences could begin to surface on any further weakness in the popular averages.
Although last week’s performance had many of the characteristics of an important low, the risks remain elevated given the unstable conditions in the global markets. We would also be concerned should the extreme downside momentum resurface and/or the S&P 500 closed below last week’s low of 1865.
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** Denotes Current Relative Strength-Based Overweight Sectors
** 1 ranking = strongest sector - 10=ranking weakest sector
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All investing involves risk, including the possible loss of principal; there can be no assurance that any investment strategy will be successful.
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Evan R. Guido
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