Morning Thoughts October 19

After a little breather on Monday stocks continued their ascent on Tuesday on solid volume and breadth.  The S&P 500 is again at the very top of its 2.5 month trading range as it closed at 1225 and change.  The immediate support level at 1190 held and after a little backing and filling in the early going, which then sparked a 2% rally on the day, led by the financials.

Stocks and the euro further extended gains as the Guardian reported that France and Germany agreed to boost the European rescue fund to 2 trillion Euros as further aid to resolve the region’s sovereign debt crisis.

The below chart of the S&P 500 index shows the 1250 level (long horizontal white line), which is where the S&P 500 broke lower from in early August.  The 1250 level also coincides with the 61.8% Fibonacci retracement level of the move from the April highs down to the August lows and as such is a) an important target area on the upside and b) a potential resistance zone.   

In classic ‘risk-on’ mode investors strongly favored cyclical stocks over the defensive sectors.  The story of the day yesterday was the sharp rally in the financial sector.  Banks led the march higher after earnings reports from Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS).   Morgan Stanley (NYSE:MS) for example closed 9% higher on the day.  The charts too show that yesterday may have been an important day for the banks.  In the case of Morgan Stanley (NYSE:MS), the stock rallied solidly above its 50 day simple moving average (blue line) and a resistance line.  Volume too was not too shabby.   

The broader market is arguably somewhat overextended at current levels, which however is more a function of the acceleration which took stocks to current levels as opposed to the levels themselves.  The chart below compares the SPDR S&P 500 ETF (NAR:SPY) to the SPDR Financial Sector ETF (NAR:XLF) and points out the relative underperformance of the financial sector in recent weeks.  Given yesterday’s rally in the sector it ought to be feasible that should the broader market consolidate some in coming days by trading a little lower, the financials may outperform.

I often point out the semiconductor complex by way of the chart of the Philadelphia Semiconductor Sector Index.  It often serves as a leading indicator and as such I wanted to point out the resistance level it currently is sitting at.  It’s not an actionable catalyst in and of itself but something to keep an eye on.

All in all stocks might be near-term overbought, which however doesn’t mean they can’t rally higher and in the case of the S&P 500 run into the 1250 level soon.  We currently find ourselves in a cyclical bear market in the context of a secular bear market.  Bear markets are vicious and overbought readings don’t mean as much as they do in other types of environments.  The market can continue to rally due to the deadly combination of short squeezes and performance chasing, while at any time being subject to stop mid-track and reverse lower just as quickly.

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