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Stocks Seek Direction in Wake of Fed, Elections

Sunday, 07 Nov 2010 02:46 PM

 

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Wall Street navigated through three major landmines last week -- the elections, the U.S. Federal Reserve meeting and jobs report -- with barely a scratch. Now what?

With earnings season winding down and a light economic calendar this week, the market will be left to its own devices to sort out its direction.

A rise of more than 16 percent in the S&P 500 since the start of September had many investors expecting a pullback after the trio of big events. But it appears to have emboldened them instead.

The CBOE Volatility Index, a measure of market anxiety, has slipped below 19 and the late-week action suggests a market getting ready for more gains -- not a sell-off.

"Some of the alternatives to stocks (bonds, cash, etc.) now look much less attractive, which should push money in the direction of stocks," said Bill Luby, a private investor in San Francisco, who writes the VIX and More blog.

This will result in "reducing some of the downside risk for owning stocks, and also putting downward pressure on the VIX."

With the Fed supporting markets through quantitative easing, rates could remain low for quite some time. That, in turn, should help stimulate borrowing and make riskier assets more attractive. It could take data of a momentous nature -- something that suggests the economy is not responding to the Fed's plan to buy $600 billion in Treasuries -- to cause anything more than a minor slip-up in the market.

"What the Fed is doing is a consistent increase in money supply. Consistency will be much more important to the psyche of investors than big spikes," said Edward Hemmelgarn, chief investment officer of Shaker Investments in Cleveland.

That feeling permeated the market even before Friday's jobs data, which showed the fastest payroll growth in the private sector since April. It is difficult to see the market fighting Fed-led stimulus, strong corporate results and labor force improvements.

 

The Fed's intentions make the search for yield even more intense, which could bolster financial stocks in coming days.

Financials climbed solidly higher on Friday, with the KBW Bank index up 2.2 percent, on talk the Fed may allow stronger banks to increase dividends. They could continue to climb as they have underperformed the rally since September.

Call volume in the Financial Select Sector ETF SPDR fund surged, as option traders exchanged about 618,000 contracts in the XLF on Friday, led by the trading of 480,000 call options. The overall options volume was three times greater than its average daily turnover, according to options analytics firm Trade Alert.

A correction might still occur, though. A number of indicators suggest the market is in position to consolidate.

The 14-day relative strength index is at 88.5. A reading above 70 usually indicates an overbought condition. However, some analysts say the indicator for an overbought market expands in a bull market. So this level may not necessarily be a bearish indicator.

Bespoke Investment Group noted the rally has put the major indexes and sectors into "extreme overbought territory" in the near-term, with the S&P 500 and six sectors at or near two standard deviations above their 50-day moving averages.

"Some sort of correction may be in order at some point from after the events of" last week, "and the 'feel good' holiday seasonality period looming a few weeks away," said Robert Zavell, a derivatives analyst at Jones Trading. "Is it possible we will be up every day from now through New Year's? I thought not every day, but you never know."

The S&P 500 faces strong resistance at around 1,228, a key retracement of the benchmark's slide from its historic high in 2007 to the 12-year low in March 2009.

The first attempt at piercing that level in April failed and preceded a decline that took the S&P to its 2010 low in early July.

"It's the second test of a very important number so what the market does here is pretty critical," said Richard Ross, global technical strategist at Auerbach Grayson in New York.

"The difference from last time is that we had a pretty sizable correction from that April high, so we have a much stronger base now," he said.

Another factor that may add fuel to the breakout is performance chasing, with investors who may be behind the rally jumping into winning stocks with the hope they will continue to gain in an effort to enhance their portfolio's performance.

"You are seeing momentum investing -- managers just moving into stocks that have been doing well," said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.

© 2014 Thomson/Reuters. All rights reserved.

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