Saturday, February 12, 2011

Is The Market Being Irrational On The Upside?

In a severe stock bear market it is often said that the market can remain irrational longer than an investor can remain solvent. In a market like investors are experiencing at this moment, some believe the market is being irrational on the upside. At what point in time will we see investors react by jumping in because they fear being left behind and missing out on significant upside gains? Year to date through February 11, 2011 the S&P 500 Index is up 5.9%. On a 12-month basis the S&P is up over 22%.

As the below chart of the S&P 500 Index shows, the market has almost steadily moved higher since the end of March last year. In the last half of 2009 the market's increase occurred on steadily declining volume on both up and down days. A similar pattern seems to be repeating itself this year. In other words, a spike in volume on up days does not seem evident; thus, suggesting the individual investor has not capitulated from sitting on the sidelines. The one spike in volume on an up day occurred in early December when the chart pattern completed its cup and handle pattern.

From The Blog of HORAN Capital Advisors

Additionally, the solid green line in the above chart shows 93% of S&P 500 company stock prices are trading above their 150 day moving average. Strategist often cite this as a sign the market is overbought. Keep in mind though, as highlighted in the chart, this variable can stay elevated for an extended period of time as it did in late 2009 into early 2010.

Certainly the market is not likely to advance at a 6% pace every succeeding six weeks. However, from a valuation perspective, many high quality large cap U.S. stocks are trading at attractive valuations. There are challenges ahead for a number of firms, like the need to pass on higher commodity prices. A pullback in the market would be healthy, and many investors seem to be waiting for that to occur. In the end, the market will trade on fundamentals.

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