Crossroads?

I've posted a rather busy chart today that I hope shows what we've been going through and our current thinking regarding the markets.{You can double click on this to make it larger}.

 

1. Volatility: Stocks are more volatile today. Here's why I think this is so.

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  Market is influenced more by short term traders and program trading than ever before.
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  Instant transmission of information
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  Cost an ease of which multiple trades and block trades can be put through the system
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  Lack of traditional market making by specialist firms and trading desks.

2. Volatility means that stock price gains and losses are compressed in time. What used to take a month or longer to occur now seems to happen in weeks or less.

3. We highlight in the chart above that stocks began to decline in earnest when President Obama went after the banks and financial sector in response to Scott Brown's win in Massachusetts. This decline has also been exacerbated by debt concerns within certain European Union countries. It is our opinion that the real reason that stocks started to decline was that they were so overbought from last year's rally that almost anything would have lead to some sort of sell off.

4. Money flow analysis is now indicative of a crossroad event. That is we will be able to garner certain clues about where stocks might be headed by their reaction to certain nearer term outcomes. For us, if stocks are able to rally through the downward sloping trendline {pictured as the thin blue line declining left to right in the chart above}, then we think there is a greater likelihood of a further short term advance for share prices. On the other side, a market that decisively takes out last Friday's lows would to us be indicative of a market that has further to go on the downside.

5. We think the evidence is indicating some sort of near term rally. As a result we have become slightly less defensive in our investment thinking in the shorter term. We of course stand ready to change this thesis should some of our money flow indicators continue to deteriorate.

6. However we also think that stocks will spend the next 4-7 months in some sort of trading range. If we had to guesstimate that range we think it would be between  1000-1120 on the S&P 500. Please understand that these prices should be considered simply our best guess as to what might occur. Events could warrant much higher or lower prices over time. We base these numbers simply on our current understanding of our different levels of market analysis. We will base our current investment posture in client accounts based on this analysis and the points we make below.

7. We believe that the retreat in prices have led to levels of valuation that are attractive in both the longer term and shorter term horizon based on what we perceive to be the current levels of economic growth. This is particularly true in certain sectors that we believe are showing attractive fundamental business prospects and seem to us to have been unfairly punished in this latest market decline.

8. We are currently publishing our end of the year investment letter to clients on this blog in serial form. Based on the economic evidence currently available to us we see no reason that those year end target levels for the S&P 500 mentioned in that letter cannot be reached.  More attractive levels of valuation married with positive business fundamentals in both the economy and individual sectors has moved us to a more positive assessment of stock prices longer term even though we expect stocks to be range bound for a certain period of time. We will marry this analysis with what we believe are appropriate account tactics for clients based on our understanding of their individual investment goals and risk/reward parameters. Once again we will change that thesis over the coming months if events warrant such a conclusion.

*Long ETFs related to the S&P 500 in client and personal accounts.