Your Cheat Sheet for the Trading Week Ahead, Jan. 16

This week, major U.S. markets and related exchange traded funds continued the uninterrupted upward climb that has been in progress for the last seven weeks.  We’ll discuss the technical and fundamental details in a moment, but clearly, as the classic Led Zeppelin tune suggests, we are “buying a stairway to heaven and that if we all call the tune, the piper will lead us to reason…”

So far, U.S. markets have followed the piper and the siren song of quantitative easing, more commonly known as QE2.  However, I fear that one day we might well discover that our stairway lies on nothing more than the whispering wind.

On My Radar

Technically, the charts look like this:

chart courtesy of StockCharts.com

The S&P (NYSE:SPY) has been “climbing the stairway to heaven” since the last small correction in late November, never once closing below its 10 day exponential moving average and remaining in overbought territory on both RSI and Stochastic indicators for the entire period.

In contrast, the Shanghai Composite (NYSE:FXI) has been in a significant correction and the chart below contrasts a QE2 versus non QE2 environment, with the Shanghai overlay on the S&P 500.  You can see how these two markets moved in tandem until QE2 started in November and have diverged ever since.

chart courtesy of StockCharts.com

The View From 35,000 Feet

Last week the news was mixed as retail sales declined and missed expectations, coming in at 0.6% versus 0.7% expected and a prior reading of 0.8% in November.

Industrial production advanced while consumer sentiment declined unexpectedly to 72.7 from expected 75.5 and 74.5 prior, due largely to concerns over unemployment that unexpectedly climbed in the Thursday report.

The Consumer Price Index rose +0.5%, with large gains in the cost of energy and fuel.

Moody’s and S&P warned about the deteriorating financial situation in the U.S. that eventually could put its AAA credit rating at risk, but that didn’t seem to bother the Boston, St. Louis and Richmond Federal Reserve Presidents who reaffirmed that QE2 would continue in spite of improving economic conditions.

Overseas, Greece debt was downgraded to junk by the Fitch rating agency and European Finance Ministers meet this week to try to sort out the mess in which they find themselves while Ben Ali, the long time leader of Tunisia, had to flee to Saudi Arabia as riots consumed his country.

In China, the People’s Bank of China raised their bank reserve requirements yet again in their ongoing battle to quell inflation and that action has been largely responsible for the decline in their main index, the Shanghai Composite.

Earnings were positive with JP Morgan (NYSE:JPM) and Intel (NASDAQ:INTC) leading the charge, and this week, earnings season kicks into high gear where it will stay for the next couple of weeks.

What It All Means

It is certain now that “QE2” has lifted stock prices but has done little for the real estate market (NYSE:IYR) or employment. It also perhaps has helped corporate profits, although with single digit top line growth and double digit bottom line growth in many cases, much of the profit growth still seems to be coming from cost cutting rather than improved sales.

Interest rates are rising, some say due to improving economic conditions, others say due to fear of oncoming high inflation, but as we all know from Economics 101, rising interest rates are seldom conducive to rising stock prices.

It’s a difficult time for value investors and fundamentalists, as many of their calculations indicate an overpriced market, and it is difficult for technicians, as well, who look at things like sentiment, RSI and stochastic and find the markets overbought and looking dangerous even as prices continue their climb.

I’m old enough to remember the “stagflation” of the 1970s, a period of both high unemployment and inflation at the same time, and if that is the net outcome of this entire stimulus, then our stairway to heaven is truly built on the whispering wind.

In my opinion, the bottom line remains the same: “the trend is your friend until it isn’t.”

The Week Ahead

A huge week of earnings and economic reports lies ahead.  On Tuesday we get Citigroup (NYSE:C) in the morning and Apple (NASDAQ:AAPL) and IBM (NYSE:IBM) after the close.  Wednesday brings Wells Fargo (NYSE:WFC) and Thursday has Morgan Stanley (NYSE:MS) in the morning and Google (NASDAQ:GOOG) in the afternoon.  Friday unveils results from Bank of America (NYSE:BAC) and General Electric (NYSE:GE).

Based on early returns from JP Morgan (NYSE:JPM) and Intel (NASDAQ:INTC), tech and bank earnings are likely to be strong while economic reports, particularly housing, are likely to be more subdued.

Economic Reports

Tuesday: January Empire Manufacturing, January NAHB Housing Index

Wednesday: December Housing Starts, December Building Permits

Thursday: Initial Unemployment Claims, Continuing Unemployment Claims, December Leading Economic Indicators, June Philadelphia Fed

Sector Spotlight

Winners: Spain (NYSE:EWP), Italy (NYSE:EWI), France (NYSE:EWQ)

Losers: Peru (NYSE:EPU), Silver (NYSE:SLV), California Municipal Bond (NYSE:CMF)

Monday marks Martin Luther King Day, honoring the birthday of the famed civil rights activist and Nobel Peace Prize winner.  His famous “I Have a Dream” speech, delivered to 200,000 people on August 28, 1963, in front of the Lincoln Memorial is widely regarded as being one of the major events in history of the American civil rights movement.

Today, nearly 50 years after Dr. King shared his dream, our nation has its first sitting African American President, and one can only rejoice in the power of the American Dream and join Dr. King when he said, “let freedom ring.”

Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds and positions can change at any time.

John Nyaradi is the author of Super Sectors: How To Outsmart the Markets Using Sector Rotation and ETFs.

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