an tSionna {8.17.09}

On August 5th I posted that I wouldn't be surprised to see stocks at least pause in their rally and possibly give back some of July's gains. I thought there were a variety of reasons why stocks might do so and the link above will give you the reasons I thought that might occur.

What I did not list in that post was that there's been all sorts of evidence in the past few weeks that economic activity has slowed. This was made even more apparent last week when the Federal Reserve issued a less than glowing forward economic outlook. Stocks took one look at that, also digested some weaker economic forecasts from certain technology companies, and printed a 3% decline on Wednesday.

That decline has likely broken the forward momentum for stocks now. That doesn't mean we can't have a snap back rally given the magnitude of last week's decline. Stocks sold off too far too fast and the likelihood will be that traders will attempt some sort of rally to at least see if they can get some positive traction going. However, probability suggests that it will fail at some point along the blue downward sloping trend line I've shown in the chart above.

I've also shown the next levels of support should we continue to see some weakness. I think absent some additional news not already factored into the market the current valuation metrics likely means there is a decent floor underneath stocks. But I think we'll see some listless nontraditional activity now until at least after Labor Day when Wall Street traditionally comes back to work.  This would allow us to work through the over bought situation that we're currently in.

Valuation's basic metrics say that the longer term risk return for stocks, given what we know today, is still attractive. However after taking into account the forward economic estimates and adjusting earnings to what a slower growth environment could mean, I think it's prudent to take down my end of the year market target as well as 2011 numbers. I've already lowered my S&P 500 target estimate for 2010 back on July 19th. to a range of 1225-1300 for year end. I'm going to lower that estimate another notch to 1160-1260 and will use a 1215 midpoint for year end. I will use 1300-1350 as a going forward estimate for year end 2011 at this point.

This is an end of the year reduction in E&P estimates of about 3.5%. I would note that from where stocks closed today {roughly 1080 on S&P 500} I still believe that they are undervalued with price potential on an estimate basis of approximately 12-20% over the next 18 months. No changes in the game plan right now and no change to our market view although I am inching closer to making a short term change, especially if I see some signs that stocks might try to rally up to that blue trend line described above in the chart.

I'm not there yet, may not get there, and would emphasise that would only be for some of our shortest term strategies.

*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.