S&P 500 Fortifies 1,100 Stronghold

As we have traded "the recession waiting game" for the past eight weeks, the market has acted very predictably. But last week brought the test of the lows that bears were hoping would finally fail, and it didn't.

"Is the bottom in?" Two weeks ago I asked and answered this question. I said it was possible, and probable especially if the S&P 1,150 level were to hold. Now after the remarkable test of S&P 1,120 I am asking again and offering a slightly more optimistic perspective.

This bounce off of 1,120 could prove to be very telling as we head into earnings season and into more precise forecasts about second half GDP. Here's the chart which tells the tale of a market bouncing off of what is now an extremely strong base.

All of my commentary since August 1 (the first trading day after the awful GDP revisions we got July 29) has been focused on how the market would price-in a probable recession -- and then wait to find out if it would actually show up.

I said this process would run into October. That's a prediction I made on August 5. And it's proven to be one you could bank money on. On August 17 I showed a chart explaining why S&P 1,100 was such an "extreme value area."

But what have I done for you lately? I was finally fooled by the trading range head-fake as it broke support at 1,135 -- and last week I even warned that this was likely and I was due soon for misstep.

So now I think it's worth paying even closer attention to macro data and earnings estimate revisions and what they signal about the lower probability for recession. It's very likely now that we are moving away from a 50% chance for recession.

Why? Because institutional money managers are telling you that their forecasts are improving with the price action in equities, commodities, and cyclically-sensitive sectors in general. Granted, industrial, energy, and materials areas had taken a beaten on global recession fears and were due to snap back.

But even the commodities themselves are making a surge back as risk is once again sought, not feared. Spot copper's sell-off to $3.30 was definitely signaling intensified recession fears and crude oil headed toward $75 again looked like further weakness would prevail. Their price jumps today back to $3.45 per pound and $84 per barrel are encouraging. Even the dreaded euro is up!

Here's a look at sector performance of the S&P 500 for the past five days and the past three months, as of noon ET Tuesday:

Financials obviously had some room for short-covering as well. But the real message of this tape is that if catastrophe is off the table for Europe, even a slow-growth US economy has lots of equity bargains.

Despite my short-term bearish stance on the break-down below 1,135, I have been and remain a stock market bull -- particularly for longer-term investors. As I've said many times, I think the global economy will work it's way out of its debt hangover with growth.

What to Watch For

In the next six weeks, I think that the market will continue to range trade. But since a lot of worry has subsided now that European financial leaders appear to be taking care of their house, the trading range may now occupy a higher territory above 1,140 until the market perceives a bad recession is definitely off the table.

Again, even the "muddle-through" 1%-GDP economy that Steve Reitmeister speaks of can be a good environment for stocks because institutional portfolio managers will be putting money to work, not running for the hills. This is where the Zacks Rank should really shine by sifting out those few companies at the top with earnings momentum.

And probably some of the best news is that the market is no longer trading off of QE3 expectations or the hope of big fiscal stimulus. Big investors aren't looking to Washington anymore to save them. Granted, they've already got easy money locked in until 2013.

But they also have to contend with slow growth, so it doesn't make their job any easier if deflation -- or worse, stagflation -- are the threats. At least now they know the economic landscape will remain relatively unencumbered by further policy faux pas or Hail Marys.

Here are 3 things to pay attention to in the coming weeks:

Earnings estimate revisions (EER) -- of the downward variety: Are Wall Street analysts climbing over each other to lower forecasts, or is the pace pretty mild? Obviously, any upward revisions are all good news.

GDP forecasts and macro data that rule out recession: Big banks, brokers, and economic research houses will start to get more clarity about the economy and their general mood can be used just like EER -- when the consensus moves from 45% calling for recession to less than 30%, with projections above 1% growth for the rest of 2011 and into 2012, stocks will get even more bid.

Earnings season: We haven't had any real wicked pre-announcements that I can recall. The reaction to both misses and beats will tell us what most fund managers have priced-in. As expectations seem to turn toward glass-half full investing, all we have to do is watch what happens. If stocks survive and thrive during a good mix of misses and beats, good things are in store into year end.

Post-close note: As I was wrapping up this article and inserting the charts, the market saw a healthy round of profit-taking in the final hour. That doesn't change my view here of a new higher trading range off of the strong support at 1,120. Until we have more visibility about the macro environment and earnings going forward, volatility within the range is to be expected and embraced.

Kevin Cook is a Senior Stock Strategist for Zacks.com

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