For much of the last 10 years, stocks have rallied on a simple formula. Positive economic growth combined with an accommodative Federal Reserve has kept equities chugging steadily higher. Critics have long predicted that this was unsustainable and that a day of reckoning would soon arrive, but they have not been able to time a turn with any degree of precision.
At end of September, this recipe for a steady uptrend began to unravel. The Fed, which has been raising rates for a while, maintained a hawkish view and signaled that more rate hikes were coming in 2019.
The problems began when the market began to worry that economic growth was starting to weaken. Emerging markets and the Chinese economy had already been exhibiting weakness for a while, but the concern was that a combination of trade wars and the waning effect of tax cuts would slow the economy.
The problem with a slowing economy was exacerbated by concerns that the Fed was misreading the economy and was incorrectly hawkish. Chairman Jerome Powell, upset the market with some poorly communicated comments following the Fed rate hike in December. That accelerated the downtrend and let to a dramatic dip on Christmas Eve.
The markets have bounced back from that deluge of selling in large part due to large allocations into equities by pension funds as the new year started. The market was oversold and due for a good bounce -- and that is what happened.
On Friday, the market saw a revival of the formula that it has loved for so long. There were very strong jobs numbers indicating that the economy was still strong and, to make it even better, Chairman Powell softened his hawkish tone and called into the question further interest rate hikes.
The timing was fortuitous and helped the recent oversold bounce to gain further traction. Although volume was a bit light, it was heavy enough on the NYSE to produce a technical follow-through day, which put the market back in a "confirmed uptrend" using the methodology employed by Investors Business Daily.
The big question now is whether the market is back on track and ready to recoup the sizable losses of the last few months. There is still the trade war issue to cause some concern -- and there is no question that there is significant economic weakness in China and other countries -- but can U.S. investors regain some optimism now?
Having an accommodative Fed is a major positive, but it would be a mistake to read too much into the December jobs news. We just had a report that Apple (AAPL) suffered from fallout due to weakness in China -- and there are sure to be others that suffer as well.
Earnings season is going to start soon, and the reaction to that will determine if the market can really start to uptrend once again. Plenty of stocks have been unfairly punished lately, but there is also much overhead resistance and many market players looking to escape if they can recoup losses.
The strong bounce since December 26 has relieved many concerns, but it has left many stocks extended and without good entry points. What is needed now is some consolidation or even a pullback. If recent lows hold, then good bases of support will form and that will create favorable setups into earnings season.
Conditions look much better now than they did a week ago, but that doesn't mean we should rush out and load up on long positions. We need to remain selective with buying and make sure the market finds some good support.
I am still holding very high levels of cash and am not seeing much that is set up in a way that I'd like. I plan on tracking some key names I favor -- and when I do buy, I will manage positions tightly.
The potential for more upside from here is good, but it is not likely to be a smooth ride.