Rally Continues; Timing Outlook Remains Positive

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1. Summary

The market finally rose out of its tight trading range in the second half of December, with the S&P 500 piercing 1120 last week (actually getting over 1125) before falling back on Thursday (the last trading day) to finish at 1115. The 1120 mark had been viewed by market technicians as “resistance” on the rally, and the extended sideways market—with the failure for several weeks to exceed 1120—had led some to suggest the 10-month rally was over. Now that 1120 has been exceeded, we’ll see whether the rally will continue.

The Timing Outlook suggests that it will, remaining positive at 8.5, same as last time. This is the 19th consecutive positive reading, essentially coinciding with the market rally that began on March 10, 2009. The rally has lasted almost 10 months and risen 65% without so much as an 8% correction along the way. One note: For the first time since the rally began, a single component of the Timing Outlook turned negative: The P/E of the S&P 500 (as computed by Morningstar) hit 21.3, just above the neutral-range cutoff of 21.2. This will be worth watching over the next few weeks. Is it the canary in the coal mine?

With the turn of the new year, the next earnings season is right around the corner. Last earnings season brought mostly positive news, with about 75% of companies beating earnings expectations and around 60% beating revenue expectations. Forward-looking statements were mixed, but it would be fair to call them slightly positive on average. As regular readers know, I think this whole rally has been news-driven, and I think it will continue to be that way. If we get positive news, on balance, I believe that the market will respond positively. If the news is overall negative—particularly if it suggests that the fledgling economic recovery is stalling out—then I think the market will fall back and the rally will be over.

The fine print: The market can turn on a dime. As always, sell-stops or some other form of downside protection is recommended on long stock positions. I generally exclude from this advice stocks held for their dividends rather than for price appreciation.

2. Market Performance Since Last Outlook
(“now” figures are as of close Thursday 12/30/09)

Last Outlook (12/13/09): 8.5 (positive)
S&P 500 last time (12/13/09): 1106
S&P 500 now: 1115 Change: +1%

S&P 500 at beginning of 2009: 903
S&P 500 now: 1115 Change in 2009: +23%

S&P 500 at close 3/9/09: 677
S&P 500 now: 1115 Change since 3/9/09: +65%

3. Indicators in Detail

· Conference Board Index of Leading Economic Indicators: The report issued in December showed the eighth consecutive monthly increase. Positive. +10

· Fed Funds Rate: No change. The Fed Funds rate remains near zero. Positive. +10

· S&P 500 Market Valuation: (Source: Morningstar’s calculation of P/E based on operating earnings.) The current P/E of the S&P 500 is 21.3, up from 20.0 last time, and the first time in quite a while that this indicator has exceeded the neutral range of 17.4 to 21.2. Negative. +0

· Morningstar’s Market Valuation Graph. This indicator has been meandering small distances around 1.0 (“fair value”) since late July, 2009. It now stands at 1.02. Thus the market is “fairly valued” by this indicator. (Interesting historical data: All-time low = 0.55 on 11/20/08. Value at end of dot-com bear market = 0.78 in 10/02, which kicked off a 5-year bull market. Most recent low of 0.62 coincides with market’s March 9 low. All-time high = 1.14 at the end of 2004.) Neutral. +5

· S&P 500 Short Term Technical Trend: Although the S&P 500’s chart wandered back and forth through its 20-day simple moving average (SMA) a couple of times during its sideways period in November and December, it currently is in its most favorable configuration: Index > 20-day SMA > 50-day SMA > 200-day SMA. It may also be worth noting that the sideways action tightened up the 20-day and 50-day SMAs, which are now just about 8 points apart. Positive. +10

· S&P 500 Medium Term Technical Trend: Positive. +10

· DJIA Short Term Technical Trend: Same story as the S&P 500. Positive. +10

· DJIA Medium Term Technical Trend: Positive. +10

· NASDAQ Short Term Technical Trend: Same pattern as the other two. Positive. +10

· NASDAQ Medium Term Technical Trend: Positive. +10

TOTAL POINTS: 85 NEW READING: 85 / 10 = 8.5 = POSITIVE