Up, Down or Sideways: What's Next for Stocks?

Right before the 1930 market top, investors' felt confident about the future of stocks as they do today.

Earnings season is upon us. And thus far we've seen stocks go up on both good and bad news. What will it take to lift stocks further? And with stocks ahead by around 70 percent from their March 2009 lows, is good news already baked into prices? How much more upside potential is there?

Big financial players such as Citigroup, and Morgan Stanley revealed their bottom line and missed the Street's estimates by a long shot. Are TARP repayments to blame or are hidden crosscurrents quietly at work?

Less than a year ago, financial and banking stocks (KBE) traded more than 80 percent below their 2007 high watermark. There was a reason for that.

In 2008, financial CEO's (including Fannie Mae, Freddie Mac, AIG, Bear Stearns and Lehman) were cheerleading their own companies. In September 2008, the ETF Profit Strategy Newsletter considered the financial sector a "downward spiral with no stop-loss provision."

This proved true. In March, however, it was time to switch gears. The March 2nd Trend Change Alert in the ETF Profit Strategy Newsletter recommended to buy financial and leveraged financial ETFs such as the Ultra Financial ProShares (UYG). UYG subsequently gained over 300 percent.

One of the keys to investing is to use common sense. It makes sense, therefore, to examine banks' health, especially since the banking sector has gained nearly 150 percent in ten months.

Good earnings - lower prices, how come?

The night before Intel released blockbuster earnings, it sent the stock higher in after-market trading. Despite Intel's strength, the Nasdaq (QQQQ) and Technology Select Sector SPDRs (XLK) sold off more than the Dow and S&P 500.

Just before Intel's announcement, the Dow and S&P rallied to new recovery highs. Those recovery highs were unconfirmed by the Dow Jones Transportation Index (IYT), Nasdaq, Dow Jones Utilities Sector (XLU), and Dow Jones Total Market Index (TMW). Could this be a case of "buy the rumor and sell the news?"

Other economically sensitive sectors, such as financials (XLF) and consumer discretionary (XLY), started their decline already a week earlier.

Friday's (1-15-10) performance in financials mirrored the performance in technology. JP Morgan, the first major bank to report earnings, beat Wall Street's consensus estimate by 13 cents a share, yet the financial sector sold off.

Why? Nobody knows for sure, but here are a few clues.

Reuters reports that the bank's large mortgage and credit card businesses have seen rising credit costs, offset only by record investment banking revenue. Losses even on prime mortgages almost tripled compared to 2008.

JP Morgan Chase CEO Jamie Dimon stated that, "We don't know when the recovery is." This blunt honesty is as refreshing as it is concerning. One thing we've learned is that bank CEO's tend to be more optimistic than the situation warrants.

Is History Repeating Itself?

Right before the 1930 market top, investors' felt confident about stocks' future as they do today. The March 25, 1930, issue of the "New York Times" reported the following: "Wall Street was in a cheerful frame of mind as a result of numerous vague reports of improvement in business and industry."

No two words capture the essence of the recent rally better than cheerful and vague.

If you'd like to put a number on "cheerful," you will find that investor sentiment today has reached the same levels of optimism as in late 2007 (Investors Intelligence survey of bullish advisors) and April 2000 (American Association of Individual Investors cash allocation). We all know what happened both times.

What goes up must come down. If you had to academically quantify up, S&P 500 might be the number that marks the end of this rally.

The brand new issue of the ETF Profit Strategy Newsletter includes a detailed short, mid and long-term forecast for all major asset classes, along with target and safety levels for the U.S. stock market.

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