an tSionna 8.05.10

Chart of the S&P 500 spyder {SPY}. We've had a nice rally off the bottom that we put in in recent weeks. The SPY is up over 10% since then. Given what we've seen this summer, the playbook suggests we have to start considering the possibility that we'll see some sort of pause in this rally over the next few weeks or so. As always we take a weight of the evidence approach. Here's why that sort of analysis suggests we could see the "pause that refreshes" going into the fall:

1. Entering the most seasonally weak period for the stock market. Forget monthly returns! Data suggests that the period from roughly late August to early-mid-October is seasonably and historically the worst investment period for stocks. I could write forever on why this often happens. One of the main reasons I think is that between now and Labor Day most of Wall Street is on vacation. I've always thought that plays a big part in getting the bearish ball rolling in most years. Wars, pestilence and market crises also seems to arrive during this time. This doesn't mean stocks have to go down. It does mean that we need to be aware of where we are in the calendar.

2. Great return since July. As I've already mentioned stocks are up big in a relative short period of time. At some point profit taking is going to kick in.

3. By and large economic data has started to skew more negative. While I don't think that derails the bigger picture {stocks in my opinion higher by the end of the year, economy growing at a slower pace than is normal post most recessions} I do think it could be seen as a headwind and give investors a reason to lock in profits if the data continues to point towards more weakness in the months ahead.

4. News cycle will increasingly focus on the fall elections. Investors hate uncertainty. This will hang out there until the market decides who will be the winners and losers.

5. Becoming over bought in all three of the time frames we follow. I should have said exactly this sentence in the chart captions above instead of implying we are already there. We are approaching levels in terms of money flows into and out of stocks that has historically suggested caution.

The game plan's response to where we are right now is to take a wait and see approach. While the evidence suggests we could take a pause in the market's advance there is no current evidence that this is happening. Markets have shown resilience to bad economic news recently, suggesting that much of what we might see in the coming weeks may already be priced into stocks. The markets may also be sniffing out some very positive scenario that investors don't see yet and could confound all of us by heading higher into the fall.

In general though the game plan suggests at least we become a bit more defensive shorter term in our thinking and attitude of where we are right now with stocks. Broadly speaking that means that for the most part we are not buyers of securities for growth accounts at this time {exception to this is some new money that has come to us of which part of the accounts need to be invested}. I am also defining levels where I would become more defensive for clients based on their investment strategy and risk return parameters should markets take a turn for the worse.

I have been Net Market Neutral  recently in the shortest term we follow. I will keep that rating although to be fair I have been, and plan to be, a bit more aggressive regarding some shorter term trades in one of our more aggressive strategies regarding protecting short term trading profits we have in those accounts. I am leaving the net market positive ratings for both longer and middle term periods. I still think stocks are attractively valued longer term and nothing here changes my thought process that stocks could still be higher from here {1220-1300 by year end, 1260 possible mid-point year end valuation }. But I think it is possible that sellers could begin emerging soon. I want to alert you to that possibility.

One final thing. I always follow the consigliere 's  maxim that "market's will do what they need to do to prove the most amount of people wrong". I define his definition down to "what would cause the most hurt to the majority of market traders". I think the most hurt would be this. Market moves up to around 1150 taking out that next resistance level we've shown above. That would force all sorts of people to feel like they are missing a major move-forcing them into stocks. Then I think a sell-off from there would cause the most amount of pain. We'll see!

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

Please note that what is posted here is solely our market opinion and not a recommendation to buy or sell securities or a recommendation on where the market might be headed.  I post for the benefit of clients and friends of my firm, Lumen Capital Management, LLC.  You should not act on any articles posted here without consulting your own invetment advisor or doing your own homework.  Better yet, hire us and we'll show you how we use our investment disciplines.