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Wow. Huge rally for stocks yesterday. All the major indices have now broken above critical resistance levels. For the S&P 500, that level was 956.
The question for investors now: Is this a sustainable move, or are we experiencing some kind of a blow-off top?
The reason I ask should be obvious. Corporate earnings have come in better-than-expected virtually across the board so far. Only 16% of the S&P 500 that’s reported so far has missed expectations.
But we know that expectations were extremely low. And we also know that the rise in earnings we’ve seen is the result of cost-cutting. Only a handful of companies have indicated that revenues are rising. Cost-cuts are essentially a one-time thing. They don’t support improving earnings over the medium- or long-term.
Now, the recent rally certainly seems to be fueled by the expectation that companies have turned the corner to improved profitability. And while it’s possible that demand is returning, there’s virtually no evidence to support that.
*****Improved home sales numbers are the result of foreclosure pricing and improved bank profits are the result of accounting changes – these are short-term benefits. Auto sales aren’t improving, retail sales are mixed at best and, most importantly, unemployment is still on the rise.
So exactly why are stocks rallying?
It’s true that confidence in the economy and financial markets has improved. And the fact that companies are able to scratch some profit out of this hard-pan economy is good.
But let’s not ignore the bears. There can be no doubt that many short positions were initiated coming into earnings season. The indices were rolling over and oil prices, the key leading indicator for economic growth, were falling. When shorts are forced to cover, it provides fuel for higher prices. I have no doubt that shorts have been buying to cover their positions.
But that can only be part of the story…
*****Unfortunately, the rest of the story is yet to be written. The S&P 500 just closed above support at 956 for the first time yesterday. It’s going to need to prove it can stay above that level before this rally can be considered the "real deal."
In the meantime, I’ve been using this strength to take some gains off the table. I took 65% and 20% on two stocks at SmallCapInvestor PRO. I took 17% gains on Activision (Nasdaq:ATVI) at Top Stock Insights and TradeMaster Daily Stock Alerts‘ Jason Cimpl took 11% on a quick trade in that service.
(Note: to find out more about the profits that Top Stock Insights readers are seeing, like ATVI, click here for information on our updated Predictions Issue. Readers are 11 for 14 for the year, or in baseball terms, batting .785. Not bad. Click here for more.)
In my view, taking profits is always good. But it is especially important when you’re uncertain about what’s going on in the stock market. Why continue to risk money when you’ve already got profits locked and the outcome is questionable?
*****The current bullishness seems to be based on the expectation/hope that the U.S. economy is bottoming right now. And that means growth may be ahead. Of course, that would be growth after a ridiculously deep contraction, but that’s not really the point, not when that contraction has been pretty well priced in.
To illustrate the potential for the bulls, here’s an easy to understand analysis by the Wall Street Journal. They’re suggesting that we may be hitting bottom.
*****Finally, here’s TradeMaster Daily Stock Alerts‘ Jason Cimpl and his weekly market forecast video. Click here to watch the video and find out why the market did what it did this week and more importantly, Jason’s expectations for next week. Click this link to watch the video now or go to trademasterstocks.com/videoreport.
Ian Wyatt
Editor
Daily Profit