Market Outlook: Simple Indicator Could be Invaluable in This Market Environment

Last week, stock prices reacted to the news. Stock picking could become more important as the market reaches new highs, and one technical indicator could be helpful to traders looking to avoid downside surprises.

It Is Becoming a Market of Stocks

Fed chair nominee Janet Yellen confirmed that quantitative easing and low interest rates should continue for the foreseeable future. Traders seem to believe this is good news, and SPDR S&P 500 (NYSE: SPY) gained 1.56% last week.

The ETF has now closed up six weeks in a row. SPY has had a winning streak of this length 15 times in the past 20 years. In the short term, this winning streak offers us little information. The next week closed up seven times and lower eight times. Longer term, SPY was up six months later 80% of the time.

The winning streak is interesting, but in the long run, stock prices are driven by earnings, and the trend in earnings is likely to determine whether prices are higher or lower six months from now.

Earnings season came to an unofficial end when Wal-Mart (NYSE: WMT) reported last week. On this front, the results were mixed. Among the large-cap stocks in the S&P 500, Standard & Poor's reports 66.59% beat earnings estimates, the best beat rate in at least six quarters.

For the broader market, according to Bespoke Investment Group, only 58.6% of 2,268 companies beat expectations. Bespoke noted, "Since the bull market began in March 2009, this is the second worst earnings beat rate we've seen. Only Q1 of this year was worse."

This mixed picture is typical of the challenge confronting investors. Success requires sifting through data that can be conflicting to find what matters the most to traders at any particular time. This week, earnings seemed to drive the price action in specific stocks, but the general trend in the market may have been set by comments from Yellen, the woman who will replace Ben Bernanke as head of the Federal Reserve.

Yellen is expected to be much like Bernanke from the perspective of investors. As she explained in testimony to the Senate, interest rates should remain low and quantitative easing will continue in an effort to lower unemployment.

This environment is generally good for companies, and earnings are likely to continue drifting higher, but in an unpredictable way. Investment success will most likely come from getting the larger trend right and being in the best stocks. Relative strength (RS) can be a valuable tool in this market environment.

Cisco Systems (NASDAQ: CSCO) missed estimates and fell more than 10% the day after the announcement. Prior to the announcement, RS indicated the stock was weak and should be avoided.

CSCO Chart

Boeing (NYSE: BA) has been a leader in RS, and the stock jumped when the company beat expectations in the most recent quarter.

BA Chart

For now, the stock market is bullish. However, not all stocks are bullish. Many traders are hoping for a turnaround in J. C. Penney (NYSE: JCP), but they have been disappointed all year, and RS indicates they are likely to continue to be disappointed.

JCP Chart

We are in one of those markets where stock pickers can earn large rewards. It could be best to stick with stocks with high RS because these are the ones that are leading the market. Bottom-fishing might be appealing, but it is not usually profitable in a bull market.

RS Also Highlights Weakness in Gold

SPDR Gold Shares (NYSE: GLD) was almost unchanged last week, closing up only $0.04 on the week. RS has been bearish on GLD all year and remains far from a buy signal.

GLD Chart

ETFs tracking mining stocks are also on RS sell signals. We should expect the miners to turn up ahead of the metal. In a true bull market for gold, we would expect to see miners and metals showing high RS.

Investors worried about inflation could consider adding to their positions in GLD since the downside appears to be limited. However, from a trading perspective there is no reason to consider GLD a buy.

This Week's News

Inflation will be in the headlines next week, but there is little likelihood of a surprise.

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