Earnings and Economic News Has Been Good. Market Will Challenge the Highs Next Week

October 18, 2012

The market continues to grind higher and we’ve had three consecutive rallies. Support at SPY $143 held and the late day selling pattern has been broken. All of the pieces are in place for a sustained rally, but stocks don’t go straight up. We can expect choppy trading for a few days while the market takes a breather.

European credit concerns remain subdued. Overnight, Spain held a very successful bond auction. Yields continue to decline and large institutions are buying short-term debt. This is the most important piece of the puzzle and I don’t believe credit concerns will flare up in 2012.

China’s GDP grew 7.4% last quarter. That is the slowest level of activity we’ve seen in years, but it is better than feared. Many analysts believe that their economy is finding support. From my standpoint, a hard landing is unlikely this year. China is increasing fiscal spending and the PBOC has been easing. They want to make sure the leadership change goes smoothly. Earlier in the week, economic releases were good (industrial production, retail sales and exports).

Domestic economic activity has also been improving. This morning, the Philly Fed came in much better than expected. Initial claims dipped unexpectedly last week and that move was reversed. The market did not have much of a reaction to the number and last week’s number was suspicious from the start. The four-week moving average is still around 380,000. All of the releases in the last few weeks have been positive.

The focus is clearly on earnings and they have been good. Almost 20% of the S&P 500 has reported. More than 60% of the companies have beaten estimates. The most important development is that Q4 earnings guidance has been raised by 10% on average. That means companies are optimistic about the next quarter.

Overnight, eBay, American Express, Morgan Stanley and Union Pacific posted results. The reaction has generally been positive. In general, earnings warnings spooked many investors. Analysts were worried that earnings would come in light. With each passing day, those concerns will be dispelled.

Asset Managers don’t want to miss a year-end rally. Stock valuations are attractive, balance sheets are strong and interest rates are near historic lows. Money will flow out of fixed income and into equities.

There is one dark cloud, but I don’t believe it will be an issue for a few weeks. The fiscal cliff is approaching and politicians are in recess until the elections. Both parties want to postpone the event. As long as analysts believe that a deal will get done before the end of the year, this dark cloud will not produce lightning.

Markets don’t go straight up. They need time consolidate gains. Look for choppy trading with an upward bias.

I’ve been telling you to scale into long positions the last two weeks. You should be in great shape and now all you have to do is manage your profits.

I believe the market will challenge the highs of the year next week.

Stay long.
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