If the action over the past week felt vaguely familiar to you, you are not alone. Although we don’t spend much time looking for chart patterns that may or may not repeat or sifting through the tea leaves for clues as to the direction of the next move, the action last week was reminiscent of what we saw at the beginning of June. If you will recall, stocks had just broken out of a consolidation pattern and the bulls were looking for additional upside. But instead, the bulls were dealt the dreaded “breakout fakeout” as stocks went sideways for the next nine days before succumbing to the most meaningful correction of this bull move.

Take a peek at the chart below and you’ll see what we mean. Note the sideways pattern seen in early June and then compare that to what we saw over the past week. Looks similar, doesn’t it?

S&P 500:

Will things turn out the same way this time around? The bears certainly hope so and have not been shy about telling anyone and everyone that will listen that it’s time for a correction. Our friends in fur point to the fact that the S&P is now up +52% from the March 9th low and that the market’s leadership has been M.I.A. during the most recent move higher. They suggest that stocks are overbought and that the “sugar high” simply can’t last.

Keeping Our Chins Up

However, as we have tried to make abundantly clear, our view is a little more upbeat. As we explained in Thursday’s Daily State of the Markets entitled Understanding "The Trade" we believe there are two driving forces at work in the market right now. First there is the “recovery trade,” based on the idea that after the longest recession in 70 years, economies around the world are starting to move forward again. And second, we see mutual fund managers continuing to move cash off their books and into stocks.

Remember, in a bull market, it is tough for fund managers with tens of billions of dollars in their funds to outperform. This task is made even harder if your fund had moved some cash to the sidelines during the credit crisis. While most funds must stay nearly fully invested at all times, even if a fund manager had raised 10% cash in order to fund the redemption requests that were pouring in during the September through April period, these managers now realize that they will not be able to keep up with the big benchmark (S&P 500) if they aren’t fully invested. So, with the recession ending, most managers recognize that they have no choice but to get that cash back into equities.

In addition, as detailed a couple of weeks ago in our weekend report Is It Still Okay to Buy? history favors the bulls at the present time. Sure, stocks are extended and the bulls could certainly take a break in here somewhere. And we will admit that September is a rotten month from an historical standpoint. But we mustn’t lose sight of the fact that we’ve seen some very rare and very powerful buy signals over the past few months, some of which were renewed in July. The bottom line here is that our favorite "breadth surge" buy signals suggest prices will be higher six and twelve months from now. To be sure, the ride could be bumpy, but these indicators tell us the odds are at least stacked in the bulls favor.

Stalemate?

In looking at the week that was, the lack of meaningful direction in stocks this week seemed to fit the argument between the two teams. Stocks got a big boost early in the week from the reassurance that Ben Bernanke will be around for a while, and also from both the consumer confidence numbers and the results from the housing market.

But, while the economic data continued to support the global recovery theme, there was some concern about the dampened momentum out of China, where stocks fell for a fourth straight week on continued worries about a slowdown in bank lending and efforts to curb overcapacity in the cement and steel industries. In addition, there were worries that the rally may be showing signs of fatigue. For example, the Investors Intelligence bearish sentiment index came in under 20% for the first time since October of 2007. And then there is a lot of talk about a lack of catalysts following the largely better-than-expected earnings season and the idea that stock prices have gotten ahead of the fundamentals

The good news is the bulls have been able to counter the negatives being espoused by their opponents. While stocks didn’t head higher to any meaningful degree this past week, our heroes in horns point out that despite all the yammering about overbought conditions, the indices didn’t fall either. And finally, the glass-is-half-full crowd points out that there still seems to be a willingness to buy on the dips.

So, despite the calendar suggesting that traders are largely on the beach and that the month of September starts on Tuesday, we’re going to continue to side with the bulls for a while. We fully recognize that we may have to “take a punch” in the near term (October hasn’t been any picnic historically either), but our longer-term work shows that the bulls may have some more room to run before this “mini bull” market ends.

Wishing you all the best for a profitable week ahead,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

TSP Chart Review
S&P 500	NASDAQ

 

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