With the market’s favorable reaction to yesterday’s reference to quantitative easing in the Fed minutes, it appears as if more upside is in store for risk assets. As we mentioned on August 6th, with the S&P 500 trading at 1,121, quantitative easing is an important factor in all investment decisions, especially over the next few weeks. Yesterday’s breadth and volume were good, but not great. Our confidence in further upside would increase if we saw excellent breadth and very good volume on Wednesday.
After reviewing numerous charts in various time frames, reasonable upside potential for the S&P 500 appears to congregate around the following: 1,196, 1,209, 1,219, 1,250, and 1,313, with 1,313 being a relatively low probability outcome in the short-term, but still possible.
Weekly moving averages (MA) on the S&P 500 have acted as both support and resistance in the last three years (see chart below). The area between 1,184 and 1,201 should be monitored closely. On the high end, a clean break above the 190-week MA (now at 1,184) and the 205-week MA (now at 1,201), could spark surprising gains to the upside. A turn down from the 1,184 – 1,201 range would probably see an important test of the moving average bands between 1,121 and 1,105. A clean break to the downside of the 25-week MA (now at 1,105) would be bearish, and would cause us to switch to a defensive bias.
If we see some buying conviction, we are open to slightly increasing our exposure between now and the Fed’s November 3, 2010 announcement. Flexibility is extremely important over the next few weeks, meaning it is not about being right, it is about making money and protecting capital. Any purchases in the coming days need to be done with an understanding the current rally could end relatively soon. Therefore, our preference is to use flexible vehicles with relatively low entry and exit costs relative to the principal involved.