How Much Higher Do We Go?

Stocks are breaking out again with S&P 500 index clearing 1700 level and the NASDAQ above 3620 on Thursday. The change of heart overnight relative to the Fed was part of the catalyst to the upside. The other was positive news from China on manufacturing data (see below). Throw in some positive data for the US economy with ISM manufacturing better than expected and all is good in the world of stocks. Fundamentally the view optimistic, technically we cleared the previous highs set up the next leg higher, and positive sentiment is back in play. Sounds like the perfect scenario for a push higher in stocks. Then why all the negative headlines from analyst and on the financial networks? Same old story… lack of confidence looking forward.sp5

Auto sales were strong for July and all the car stocks are higher with Ford up 1.8%, GM up 1.7% and the auto index up 1.6%. Is this enough of a catalyst to push the auto stocks through the previous highs? The consolidation patterns are setting up for a break higher and continuation of the current uptrend in play. ISM manufacturing was much better at 55.4% versus the 52.0% expected. PMI was up as well to 53.7 and jobless claims fell to 326,000 almost 20,000 below last week. The only negative news came from construction spending which fell 0.6% versus up 0.4%. That is the impact of mortgage rates rising, plain and simple. Positive data to build the confidence of investors going forward… right?

Is China really doing better or not? The economic data has been mixed at best and the latest report of PMI released Thursday showed a rise to 50.3 from 50.1 for July, according to the government data. Thus, things are improving in the manufacturing sectors slightly. HSBC, private sector reading,  reported the opposite and that manufacturing was contracting as the reading fell to 47.7 versus 48.2. The contradiction of course raises plenty of questions, but the important fact is if investors believe things are improving in the country. That belief is reflected in market prices and SPDR China ETF shows a reversal off the lows in July and a positive micro trend to the upside currently. If you are willing to take a longer term view of China the outlook is positive, but there will be volatility along the way as the data struggles to improve. But, like the balance of the equity market is about confidence in the outlook.

I could go on with all the news and reports posted on Thursday, but we still have to answer the question in our own minds… how much higher do we go? Our logical side wants to define the opportunity and our emotional side wants to run for the exits in fear of another fall on the horizon. It is difficult to tell ourselves to sell when the charts and prices continue to go higher, but risk is rising and we have to manage the downside as well as the upside of our portfolio currently. There is negative divergence between momentum indicators and the trend of the markets currently. I understand and appreciate that I am following the trend, but it does not mean I cannot be cautious of what can potentially happen on the downside.

The anxiety created by the worry or cautionary views about the future can keep investors from acting on the trend currently. I am suffering from some of that is the models currently. That is not bad it is just a reality of understanding and respecting the risk of trading. With that in mind let’s take a stab at the question… how long will the S&P 500 index remains above the 1700 level?

The transports (IYT) should be an indicator for the index looking forward and it jumped 3.2% on Thursday to hit a new high. This is reinforcement of the break higher for the broad index and supports the move higher for stocks. How long? Until the buyers stop believing in the upside is my simple answer. As much as you and I want to believe the market is driven by a combination of fundamental and technical data to define the trend, in the end it is belief (emotions) and perception (momentum) of value that drive prices short term. Currently the buyers are in control and they believe in the upside, and the perception is that the economy improves in the second half. Until it breaks the trend is on the upside and we have to learn to shut up and go along for the ride, versus being the child in the car asking, “are we there yet?”