Posted August 25, 2014 7:48 am
This summer was a classic representation of a fight between the bulls and the bears. We started out with a nice rally, only to give up all of the gains and sell-off 5%. Yet, just like it has been over the last couple of years, the bulls got control of the market in the beginning of August and it has been off to the races since then.
Right now we are at an inflection point for the market. We are sitting at brand new highs of the year. The big question is are we going to form a double top at 1985-2000 and then break-down and head to 1870 (200 dma), or are we going to break out above 2000 and continue the most hated rally in history?
I bet on the latter; I see many catalysts for the market to go higher. I see a dovish Fed that does not want to raise rates ahead of schedule, and an UBER-dovish ECB that will stop at nothing when it comes to their bond-buying program.
The only negative in the market is the conflict between Ukraine and Russia. Right now, the market has baked in the conflict between Ukraine and Russia, as seen by the 5% pullback. The Middle East conflicts have not yet affected the markets. Unless any of the conflicts raise economic concerns, I do not see them pulling down the market. In fact, I think that September is setting up to be a very bullish month, but I am worried about October.
I think that investors will worry about the outcome of the U.S. midterm elections. This means that October should be a more risk-off environment than September as investors will want to wait for certainty, which will come with election results. One could argue that a Republican controlled Congress would be a positive for the market as it may make Congress more productive now that one party is in control. On the flip side, if the Republicans control Congress, investors make take that as a sign that the deadlock will be even worse, since neither President Obama nor the Republicans in Congress will feel compelled to work with each other, as we have seen over the last 6 years. Overall, I think the Q4 rally will start a bit early in September, but then go on a brief hiatus until November after the market sees more certainty.
The price action is key. One can argue a bearish case, but until I see some bearish price action, I think that the bull argument wins. We saw a perfect correction, where the S&P 500 went down to the 100 dma, and successfully bounced. This is something it has been doing for the last few years, which has led to new highs each time. We have just come off of a strong earnings quarter, where average earnings grew by more than 7%. This should subdue some valuation fears, as the broader market sits at a forward P/E of 16.5.
The next catalyst for the market will be the day after Labor Day, when new money starts to flow in. Hedge funds have significantly underperformed the market, meaning that they will need to catch up. In turn, when most fund managers come back from vacation in one week, I think we will see money flow into the financials and technology, the two recent market leaders. Following that, we have the FOMC meeting in the middle of September. This meeting will deliver many headlines as to the rate at which the Fed will raise rates. September should be a very volatile month, but if all goes as I expect, we could be looking at a nice 2-3% rally.